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The banking crisis with interbank market freeze

Author

Listed:
  • Jin Cheng
  • Meixing Dai
  • Frédéric Dufourt

Abstract

This paper studies banking crises characterized by interbank market freeze, fire sale and contagion in a model with collateralized interbank loans. We examine the role of interbank market in spreading and amplifying crises by distinguishing three sources of liquidity risks, i.e., panic-induced run, foreign sovereign debt crisis and gambling behavior. Our results underline that ex-post insufficient bank capital and/or liquidity reserves could lead the interbank market to malfunction. However, implementing more restrictive regulations to reinforce banks' resilience to shocks could hamper their role as financial intermediary and may have perverse effects on their gambling behaviors. Therefore, the crisis management by a government even without monetary sovereignty is crucial in ensuring the well-functioning of the interbank market and hence the stability of the banking system, and it is effective as long as the scale of bailout is credible in the sense of not compromising the government's solvency.

Suggested Citation

  • Jin Cheng & Meixing Dai & Frédéric Dufourt, 2015. "The banking crisis with interbank market freeze," Working Papers of BETA 2015-20, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    • Handle: RePEc:ulp:sbbeta:2015-20
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    File URL: http://beta.u-strasbg.fr/WP/2015/2015-20.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Banking crisis; interbank market; market discipline; capital ratio; multiple equilibria; bank run; gambling asset; asymmetric information; and sovereign debt crisis.;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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