A Heterogeneous Agent Model for Assessing the Effects of Capital Regulation on the Interbank Money Market Under a Corridor System
30 Pages Posted: 15 Sep 2015
Date Written: September 11, 2015
Abstract
Money markets play an important role in the implementation of monetary policy. Their structure and dynamics have, however, changed significantly in recent years. In particular, a number of new banking regulations will affect the behaviour of money market participants, and so have the potential to affect money market interest rates. This paper offers a model to examine how prudential regulation might affect interbank overnight interest rates where the central bank implements monetary policy using a corridor system. Combined with a set of assumptions as to the cost banks might incur in meeting regulatory capital requirements, it offers a framework with which to explore how such prudential regulation might affect the dynamics of overnight interest rates. The results — which are illustrative — estimate the interest rates at which banks might borrow and lend reserves overnight in the presence of prudential regulation. They suggest that risk-weighted capital requirements might increase the average level of overnight interbank interest rates, while the regulatory minimum leverage ratio might decrease it. If applied to real-world data on central bank reserves balances and regulatory metrics, this model also offers an insight into how central bank policymakers could — if they so choose — amend their operational frameworks to account for the effects of regulation.
Keywords: Monetary policy implementation, money markets, bank regulation, central bank
JEL Classification: G12, E43, E43, E58.
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