Imperfect Competition in the Interbank Market for Liquidity as Arationale for Central Banking

42 Pages Posted: 8 Feb 2010

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Denis Gromb

HEC Paris

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB)

Date Written: October 23, 2009

Abstract

We study liquidity transfers between banks through the interbank borrowing and asset sale markets when, (i) surplus banks providingliquidity have market power, ii) there are frictions in the lendingmarket due to moral hazard, and, (iii) assets are bank-specific. We show that when the outside options of needy banks are weak, surplus banks may strategically under-provide lending, thereby inducing inefficient sales of bank-specific assets. A central bank can ameliorate this inefficiency by standing ready to lend to needy banks, provided it has greater information about banks (e.g.,through supervision) compared to outside markets, or is prepared to extend potentially loss-making loans. The public provision of liquidity to banks, in fact its mere credibility, can thus improve the private allocation of liquidity among banks. This rationale for central banking funds support in historical episodes preceding the modern era of central banking and has implications forrecent debates on the supervisory and lender-of-last-resort roles of central banks.

Suggested Citation

Acharya, Viral V. and Gromb, Denis and Yorulmazer, Tanju, Imperfect Competition in the Interbank Market for Liquidity as Arationale for Central Banking (October 23, 2009). NYU Working Paper No. FIN-09-031, Available at SSRN: https://ssrn.com/abstract=1548816

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Denis Gromb

HEC Paris

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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