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Bank Size, Risk Diversification and Money Markets

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  • Hugo Rodríguez Mendizábal

Abstract

This paper presents a theoretical model based on risk diversification to rationalize the observed dichotomy in the federal funds market by which small banks are net providers of funds while large banks become net purchasers. As larger banks are more diversified they can raise a larger proportion of funds as equity and provide more loans. To finance these loans, they will need to obtain funds in the wholesale money market. In contrast, smaller banks will be less diversified and will find it harder to raise equity which means producing a lower amount of loans and supplying the extra funds in the wholesale money market. The model also produces a set of testable predictions about the performance of large and small banks that are in line with data for the US.

Suggested Citation

  • Hugo Rodríguez Mendizábal, 2014. "Bank Size, Risk Diversification and Money Markets," Working Papers 785, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:785
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    References listed on IDEAS

    as
    1. Craig, Ben & von Peter, Goetz, 2014. "Interbank tiering and money center banks," Journal of Financial Intermediation, Elsevier, vol. 23(3), pages 322-347.
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    3. Chen, Andrew H. & Mazumdar, Sumon C., 1992. "An instantaneous control model of bank reserves and Federal funds management," Journal of Banking & Finance, Elsevier, vol. 16(6), pages 1073-1095, December.
    4. Allen, Linda & Saunders, Anthony, 1986. "The large-small bank dichotomy in the federal funds market," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 219-230, June.
    5. Adam Ashcraft & James Mcandrews & David Skeie, 2011. "Precautionary Reserves and the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(s2), pages 311-348, October.
    6. Cocco, João F. & Gomes, Francisco J. & Martins, Nuno C., 2009. "Lending relationships in the interbank market," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 24-48, January.
    7. Gara Afonso & Anna Kovner & Antoinette Schoar, 2011. "Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis," Journal of Finance, American Finance Association, vol. 66(4), pages 1109-1139, August.
    8. Allen, Linda & Peristiani, Stavros & Saunders, Anthony, 1989. "Bank Size, Collateral, and Net Purchase Behavior in the Federal Funds Market: Empirical Evidence," The Journal of Business, University of Chicago Press, vol. 62(4), pages 501-515, October.
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    More about this item

    Keywords

    bank size; diversification; money market; bank solvency;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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