Bank liquidity, interbank markets, and monetary policy

X. Freixas, A. Martin, D. Skeie

Research output: Contribution to journalArticleScientificpeer-review

Abstract

A lesson of the recent financial crisis is that the interbank market is crucial for banks facing uncertainty regarding their liquidity needs. This article studies the efficiency of the interbank market in allocating funds. We show that the central bank should lower the interbank rate when confronted with a crisis that causes a disparity in the liquidity held among banks. This suggests that the traditional tenet prescribing the separation between prudential regulation and monetary policy should be abandoned. We also show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.
Original languageEnglish
Pages (from-to)2656-2692
JournalThe Review of Financial Studies
Volume24
Issue number8
DOIs
Publication statusPublished - 2011

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