Can the Us Interbank Market Be Revived?

52 Pages Posted: 26 Dec 2018 Last revised: 21 Feb 2019

See all articles by Kyungmin Kim

Kyungmin Kim

Board of Governors of the Federal Reserve System

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics

Ed Nosal

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Date Written: 2018-12-21

Abstract

Large-scale asset purchases by the Federal Reserve as well as new Basel III banking regulations have led to important changes in U.S. money markets. Most notably the interbank market has essentially disappeared with the dramatic increase in excess reserves held by banks. We build a model in the tradition of Poole (1968) to study whether interbank market activity can be revived if the supply of excess reserves is decreased sufficiently. We show that it may not be possible to revive the market to pre-crisis volumes due to costs associated with recent banking regulations. Although the volume of interbank trading may initially increase as excess reserves continue to decline, the new regulations may engender changes in market structure that result in interbank trading being completely replaced by non-bank lending to banks when excess reserves become scarce. This non-monotonic response of interbank trading volume to reductions in excess reserves may lead to misleading forecasts about future fed funds prices and quantities when/if the Fed begins to normalize their balance sheet by reducing excess reserves.

Keywords: Balance sheet costs, Interbank market, Monetary policy implementation

JEL Classification: E42, E58

Suggested Citation

Kim, Kyungmin and Martin, Antoine and Nosal, Ed, Can the Us Interbank Market Be Revived? (2018-12-21). FEDS Working Paper No. 2018-088. Available at SSRN: https://ssrn.com/abstract=3306151 or http://dx.doi.org/10.17016/FEDS.2018.088

Kyungmin Kim (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6943 (Phone)

Ed Nosal

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

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