Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank

Xavier Freixas (), Bruno Parigi and Jean Rochet

No 2325, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow banks to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking industry to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments' systemic repercussions and we examine the justification of the 'too-big-to-fail-policy'.

Keywords: Coordination; Interbank Market; Liquidity; Payment System (search for similar items in EconPapers)
JEL-codes: E58 G10 G18 (search for similar items in EconPapers)
Date: 1999-12
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Citations: View citations in EconPapers (21)

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Related works:
Journal Article: Systemic risk, interbank relations, and liquidity provision by the central bank (2000)
Journal Article: Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank (2000)
Working Paper: Systemic risk, interbank relations and liquidity provision by the Central Bank (1999)
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