Imperfect Competition in the Inter-Bank Market for Liquidity as a Rationale for Central Banking

Viral V. Acharya (), Denis Gromb and Tanju Yorulmazer ()

No 6984, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study liquidity transfers between banks through the interbank borrowing and asset sale markets when (i) surplus banks providing liquidity have market power, (ii) there are frictions in the lending market due to moral hazard, and (iii) assets are bank-specific. We show that when the outside options of needy banks are weak, surplus banks may strategically under-provide lending, thereby inducing inefficient sales of bank-specific assets. A central bank can ameliorate this inefficiency by standing ready to lend to needy banks, provided it has greater information about banks (e.g., through supervision) compared to outside markets, or is prepared to extend loss- making loans. The public provision of liquidity to banks, in fact its mere credibility, can thus improve the private allocation of liquidity among banks. This rationale for central banking finds support in historical episodes preceding the modern era of central banking and has implications for recent debates on the supervisory and lender-of-last-resort roles of central banks.

Keywords: Asset specificity; Central bank; Competition; Interbank lending; Lender of last resort; Market power (search for similar items in EconPapers)
JEL-codes: D62 E58 G21 G28 G38 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
Date: 2008-10
View list of references View citations in EconPapers

Downloads: (external link)
http://www.cepr.org/pubs/dps/DP6984.asp (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:cpr:ceprdp:6984

Ordering information: This working paper can be ordered from
http://www.cepr.org/pubs/dps/DP6984.asp

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers
Address: Centre for Economic Policy Research, 53--56 Great Sutton Street, London EC1V 0DG
Series data maintained by ().