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Interbank Markets and Credit Policies amid a Sovereign Debt Crisis

Aeimit Lakdawala, Raoul Minetti and Maria Olivero ()

No 2017-1, School of Economics Working Paper Series from LeBow College of Business, Drexel University

Abstract: Interbank markets have been at the core of the international transmission of recent financial crises, including the European sovereign debt crisis. We study the transmission of shocks in a two-country DSGE model where banks pledge government bonds as collateral in interbank markets. A standard “bank net worth channel” amplifies negative shocks to the returns of private loans. However, an “interbank collateral channel” can partially contrast the bank net worth channel. The stabilizing interbank collateral channel works through banks' portfolio switch towards government bonds, which helps sustain the value of banks' bond holdings and partially relax collateral constraints in the interbank market. Unconventional credit policies raise banks' liquidity but, if financed through government debt issuance, can undermine the stabilizing effect of the interbank collateral channel. The analysis yields insights for the optimal design of credit policies during sovereign debt crises.

Keywords: Sovereign debt; credit crunch; interbank markets; international contagion (search for similar items in EconPapers)
JEL-codes: E32 E44 F44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
Date: 2017-01-01
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