Intermediation in the Interbank Lending Market

64 Pages Posted: 7 Aug 2019

See all articles by Ben R. Craig

Ben R. Craig

Federal Reserve Bank of Cleveland; Deutsche Bundesbank

Yiming Ma

Columbia University - Columbia Business School, Finance

Date Written: January 3, 2018

Abstract

This paper studies systemic risk in the interbank market. We first establish that in the German interbank lending market, a few large banks intermediate funding flows between many smaller periphery banks and that shocks to these intermediary banks in the financial crisis spill over to the activities of the periphery banks. We then develop a network model in which banks trade off the costs and benefits of link formation to explain these patterns. The model is structurally estimated using banks' preferences as revealed by the observed network structure in the pre-crisis period. It explains why the interbank intermediation arrangement arises, estimates the frictions underlying the arrangement, and quantifies how shocks are transmitted across the network. Model estimates based on pre-crisis data successfully predict changes in network-links and in lending arising from the crisis in out-of-sample tests. Finally, we quantify the systemic risk of a single intermediary and the impact of ECB funding in reducing this risk through model counterfactuals.

Keywords: systemic risk, Interbank markets, networks, structural estimation

JEL Classification: G21, G01

Suggested Citation

Craig, Ben R. and Ma, Yiming, Intermediation in the Interbank Lending Market (January 3, 2018). Columbia Business School Research Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=3432001 or http://dx.doi.org/10.2139/ssrn.3432001

Ben R. Craig

Federal Reserve Bank of Cleveland ( email )

PO Box 6387
Cleveland, OH 44101
United States
216-579-2061 (Phone)
216-579-3050 (Fax)

Deutsche Bundesbank

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Yiming Ma (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

NY
United States

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