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Bank Credit and Money Creation on Payment Networks: A Structural Analysis of Externalities and Key Players

Ye Li, Yi Li and Huijun Sun
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Ye Li: Ohio State University
Yi Li: Board of Governors of the Federal Reserve System
Huijun Sun: Columbia Business School

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: This paper documents a strong connection between payment system and credit supply. The dual role of deposits as financing instruments for banks and means of payment for bank customers implies spillover effects of bank lending. After a bank finances loans with new deposits, the deposit holders' payments cause reserves and deposits to flow from the lending bank to the payees' banks. The change in liquidity conditions for both banks and their customers gives rise to two opposing forces that generate respectively strategic complementarity and strategic substitution in banks' lending decisions. We model bank lending through a linear-quadratic game on a random graph of payment flows and structurally estimate the spillover effects using Fedwire data to quantify the probability distribution of payment-flow network. Payment network externalities reduce the average level of aggregate credit supply by 9% while amplify the volatility by 20%. We identify a small subset of banks that have a disproportionately large influence on credit supply due to their special positions in the payment-flow network.

JEL-codes: E42 E43 E44 E51 E52 G21 G28 (search for similar items in EconPapers)
Date: 2021-12
New Economics Papers: this item is included in nep-fdg, nep-isf, nep-mac, nep-mon, nep-net and nep-pay
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