Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking

53 Pages Posted: 25 Mar 2011

See all articles by Viral V. Acharya

Viral V. Acharya

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

Denis Gromb

HEC Paris

Tanju Yorulmazer

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

Multiple version iconThere are 3 versions of this paper

Date Written: March 22, 2011

Abstract

We study the interbank lending and asset sales markets in which banks with surplus liquidity have market power, frictions arise in lending due to moral hazard, and assets are bank-specific. Illiquid banks have weak outside options that allow surplus banks to ration lending, resulting in inefficient asset sales. A central bank can ameliorate this inefficiency by standing ready to fund illiquid banks, provided it is better informed than outside markets, or prepared to extend loss making loans. This rationale for central banking finds support in episodes that precede the modern central-banking era and informs debates on the supervisory and lender-of-last-resort roles of central banks.

Keywords: Competition, Interbank Lending, Market Power, Asset Specificity, Central Bank, Lender of Last Resort

JEL Classification: G21, G28, G38, E58, D62

Suggested Citation

Acharya, Viral V. and Gromb, Denis and Yorulmazer, Tanju, Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking (March 22, 2011). INSEAD Working Paper No. 2011/41/FIN. Available at SSRN: https://ssrn.com/abstract=1792412 or http://dx.doi.org/10.2139/ssrn.1792412

Viral V. Acharya

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

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

Denis Gromb (Contact Author)

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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