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Bank Liquidity, Interbank Markets, and Monetary Policy

Xavier Freixas1; Antoine Martin2; David R. Skeie2

1 Universitat Pompeu Fabra · 2 Federal Reserve Bank of New York

Review of Financial Studies 2011

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.

DOI
10.1093/rfs/hhr018
Volume
24 (8)
Pages
2656-2692
Language
en
Export
BibTeX
Sources
crossref openalex