The Effect of the Central Bank's Standing Facilities on Interbank Lending and Bank Liquidity Holding

36 Pages Posted: 23 Jan 2018

Date Written: July 13, 2017

Abstract

How does the central bank influence interbank lending? The central bank’s policy rates determine the attractiveness of the standing facilities compared with the interbank market. Therefore, by choosing the policy rates the central bank affects the number of banks using the standing facilities and the number of banks using the interbank market. There is also a second channel. The policy rates may influence bank liquidity holding and thus the chances that interbank lending occurs. To address both channels, bank liquidity holding is endogenous in the presented model. The results show that liquidity is not held to insure against idiosyncratic risk but to lend to the interbank market in case counterparty risk is not too high. If banks expect interbank lending to be sufficiently likely and profitable, a smooth liquidity transfer at the interbank market is guaranteed. The central bank can create such a situation under the constraint that counterparty risk is moderate and counterparty risk perceptions are not too distorted. If, however, counterparty risk is perceived to be too large, this may result in liquidity hoarding.

Keywords: interbank market, liquidity holding, standing facilities

JEL Classification: E43, E58, G21

Suggested Citation

Näther, Maria, The Effect of the Central Bank's Standing Facilities on Interbank Lending and Bank Liquidity Holding (July 13, 2017). Available at SSRN: https://ssrn.com/abstract=2802496 or http://dx.doi.org/10.2139/ssrn.2802496

Maria Näther (Contact Author)

University of Leipzig ( email )

Grimmaische Straße 12
Leipzig, 04109
Germany

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