Marc Dordal Carreras, University of California, Berkeley
Abstract: Using techniques from the international trade literature, we propose a model of the interbank market that accommodates a high degree of heterogeneity in banks' characteristics and nests into a standard New Keynesian model of the economy. Interbank markets arise as the result of liquidity mismatches, and the patterns of interbank trade, market concentration and bank sizes that result are important to understand the amplification of financial shocks. We provide an analytical approximation to the gains from trade that presents a welfare trade-off between efficiency from market integration, diversification of funding sources and exposure to interbank volatility. We also study optimal central bank discount window policy, finding that an active provision of credit to distressed banks reduces the costs of financial shocks. Finally, using microdata on bilateral transactions for the universe of German monetary financial institutions, we provide estimates of the gains from trade, policy counterfactuals and welfare costs of the 2007 financial crisis.