Financial frictions and the interbank market

Abstract

This thesis analyzes the role of the interbank market in the "canonical model of financial intermediation and business fluctutations" by Gertler and Kiyotaki (2011). In the model the interbank market arises because only a fraction of firms is allowed to invest in each period. While Gertler and Kiyotaki (2011) analyze only two special cases quantitatively, I provide a numerical solution of their model with general interbank friction. The solution is used to show that a change in the interbank friction a-ects the economy only marginally. I show that the interbank market is very small compared to total credit: an upper bound is determined by aggregate investment, the fraction of firms that may invest, and asset prices. The degree of financial frictions is the fraction of bank assets, that bankers can divert. This gives rise to an incentive compatibility constraint (ICC). If it binds, there will be interest spreads between deposits, interbank trade and returns on loans. The tighter it binds, to higher the spreads. Since the (inverse) degree of interbank friction is modelled as the fraction of interbank assets which cannot be diverted, a change in the friction parameter essentially will not translate to a change in prices or quantities.