Interbank Lending, Credit Risk Premia and Collateral
46 Pages Posted: 13 Nov 2009
Date Written: November 11, 2009
We study the functioning of secured and unsecured interbank markets in the presence of credit risk. The model generates empirical predictions that are in line with developments during the 2007-2009 financial crises. Interest rates decouple across secured and unsecured markets following an adverse shock to credit risk. The scarcity of underlying collateral may amplify the volatility of interest rates in secured markets. We use the model to discuss various policy responses to the crisis.
Keywords: Financial crisis, Interbank market, Liquidity, Credit risk, Collateral
JEL Classification: G01, G21, E58
Suggested Citation: Suggested Citation