Interbank borrowing and lending between financially constrained banks

Dietrich, D. and Hauck, A. ORCID: 0000-0002-6949-6732, 2020. Interbank borrowing and lending between financially constrained banks. Economic Theory, 70 (2), pp. 347-385. ISSN 0938-2259

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Some stylized facts about transactions among banks are not easily reconciled with coinsurance 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 nonbanks. 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.

Item Type: Journal article
Publication Title: Economic Theory
Creators: Dietrich, D. and Hauck, A.
Publisher: Springer
Date: September 2020
Volume: 70
Number: 2
ISSN: 0938-2259
1220Publisher Item Identifier
Rights: © the author(s) 2019. Open Access. This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (, which permits unrestricted use, distribution, and reproduction in any medium, provided you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made.
Divisions: Schools > Nottingham Business School
Record created by: Linda Sullivan
Date Added: 18 Sep 2019 08:03
Last Modified: 28 Oct 2020 11:47

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