Did the Founding of the Federal Reserve Affect the Vulnerability of the Interbank System to Congation Risk?

Mark Carlson and David Wheelock

No 2016-12, Working Papers from Federal Reserve Bank of St. Louis

Abstract: As a result of legal restrictions on branch banking, an extensive interbank system developed in the United States during the nineteenth century to facilitate interregional payments and flows of liquidity and credit. Vast sums moved through the interbank system to meet seasonal and other demands, but the system also transmitted shocks during banking panics. The Federal Reserve was established in 1914 to reduce reliance on the interbank system and to correct other defects that caused banking system instability. Drawing on recent theoretical work on interbank networks, we examine how the Fed?s establishment affected the system?s resilience to solvency and liquidity shocks and whether those shocks might have been contagious. We find that the interbank system became more resilient to solvency shocks but less resilient to liquidity shocks as banks sharply reduced their liquidity after the Fed?s founding. The industry?s response illustrates how the introduction of a lender of last resort can alter private behavior in ways that increase the likelihood that the lender will be needed.

Keywords: Federal Reserve System; contagion; systemic risk; seasonal liquidity demand; interbank networks; banking panics; National Banking system (search for similar items in EconPapers)
JEL-codes: E42 E44 E58 G21 N11 N12 N21 N22 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2016-06-14
New Economics Papers: this item is included in nep-his, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Did the Founding of the Federal Reserve Affect the Vulnerability of the Interbank System to Contagion Risk? (2018)
Working Paper: Did the founding of the Federal Reserve affect the vulnerability of the interbank system to contagion risk? (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:2016-012

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DOI: 10.20955/wp.2016.012

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