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Lookup NU author(s): Dr Diemo DietrichORCiD,
Dr Achim Hauck
This work is licensed under a Creative Commons Attribution 4.0 International License (CC BY 4.0).
Some stylized facts about transactions among banks are not easily reconciled with co-insurance of short-term liquidity risks. In our model interbank markets play a different role. We argue that lending to another bank can reduce a bank's overall portfolio risk through diversification. If insolvency is costly, this diversification improves the interbank lender's funding liquidity, boosting credit supply to non-banks. However, diversification comes at an endogenous cost that depends on bank-specific factors of interbank borrower and lender. The model provides a framework for understanding the importance of interbank lending for aggregate credit supply and the stability of banking systems. The model's predictions are consistent with evidence documented in the literature that other theories cannot consistently explain.
Author(s): Dietrich D, Hauck A
Publication type: Article
Publication status: Published
Journal: Economic Theory
Print publication date: 01/09/2020
Online publication date: 29/07/2019
Acceptance date: 20/07/2019
Date deposited: 19/07/2019
ISSN (print): 0938-2259
ISSN (electronic): 1432-0479
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