Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank

Posted: 21 May 2000

See all articles by Xavier Freixas

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

Bruno Parigi

Università degli Studi di Padova

Jean-Charles Rochet

GFRI, University of Geneva; Swiss Finance Institute; University of Zurich - Swiss Banking Institute (ISB)

Multiple version iconThere are 2 versions of this paper

Abstract

We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow banks to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking industry to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments' systemic repercussions and we examine the justification of the "too-big-to-fail-policy".

JEL Classification: E58, G10, G18

Suggested Citation

Freixas, Xavier and Parigi, Bruno and Rochet, Jean-Charles, Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank. Journal of Money, Credit and Banking, Vol. 32, No. 3, Part II, August 2000, What Should Central Banks Do?: A conference sponsored by the Federal Reserve Bank of Cleveland, Special Issue ed. Joseph G. Haubrich, Oct. 27-29, 1999. Available at SSRN: https://ssrn.com/abstract=228970

Xavier Freixas (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Bruno Parigi

Università degli Studi di Padova ( email )

Via 8 Febbraio, 2
Padova, Vicenza 35122
Italy

Jean-Charles Rochet

GFRI, University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland

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