Interbank Networks in the Shadows of the Federal Reserve Act
38 Pages Posted: 6 May 2019
Date Written: April 10, 2019
Central banks provide public liquidity (through lending facilities and promises of bailouts) with the intent to stabilize the financial system. Even though this provision is restricted to member (regulated) banks, an interbank system can provide indirect access to nonmember (shadow) banks. We construct a model to understand how a banking network may change in the presence of central bank interventions and how those changes affect financial fragility. We provide evidence showing that the introduction of the Fed’s liquidity provision in 1913 increased systemic risk through three channels; it reduced aggregate liquidity, created a new source of financial contagion, and crowded out private insurance for smoothing cross-regional liquidity shocks (manifested through the geographic concentration of networks).
Keywords: Dual banking system, Federal Reserve Act, Shadow Banking, Interbank Networks, Systemic Risk
JEL Classification: G20, E50, N22
Suggested Citation: Suggested Citation