Can the U.S. Interbank Market Be Revived?

51 Pages Posted: 30 Jan 2019 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: 2018-11-01

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 precrisis volumes due to costs associated with recent banking regulations. Although the volume of interbank trade may initially increase as excess reserves are decreased from their current abundant levels, the new regulations may engender changes in market structure that result in interbank trading being completely replaced by nonbank lending to banks when excess reserves become scarce. This nonmonotonic 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 its balance sheet by reducing excess reserves.

Keywords: interbank market, monetary policy implementation, balance sheet costs

JEL Classification: E42, E58

Suggested Citation

Kim, Kyungmin and Martin, Antoine and Nosal, Ed, Can the U.S. Interbank Market Be Revived? (2018-11-01). FRB Atlanta Working Paper No. 2018-13. Available at SSRN: https://ssrn.com/abstract=3324894 or http://dx.doi.org/10.29338/wp2018-13

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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