Deposit Insurance and Money Market Freezes

40 Pages Posted: 13 May 2009 Last revised: 3 Mar 2010

See all articles by Max Bruche

Max Bruche

Humboldt University of Berlin

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: September 17, 2009

Abstract

In the presence of deposit insurance, a rise in counterparty risk may cause a freeze in interbank money markets. We show this in a general equilibrium model with regionally-segmented bank-based retail financial markets, in which money markets facilitate the reallocation of funds across banks from different regions. Counterparty risk creates an asymmetry between banks in savings-rich regions, which remain marginally financed by the abundant regional insured deposits, and in savings-poor regions, which have to pay large spreads in money markets. This asymmetry distorts the aggregate allocation of credit and, in the presence of demand externalities, can cause large output losses.

Keywords: deposit insurance, money markets, bank solvency, financial market freezes

JEL Classification: E2, E5, G2

Suggested Citation

Bruche, Max and Suarez, Javier, Deposit Insurance and Money Market Freezes (September 17, 2009). Journal of Monetary Economics, Vol. 57, No. 1, 2010. Available at SSRN: https://ssrn.com/abstract=1403129 or http://dx.doi.org/10.2139/ssrn.1403129

Max Bruche

Humboldt University of Berlin ( email )

Spandauer Str. 1
Berlin, D-10099
Germany

HOME PAGE: http://www.maxbruche.net

Javier Suarez (Contact Author)

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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