We study interbank lending and asset sales markets in which banks with surplus liquidity have market power vis-à-vis banks needing liquidity, frictions arise in lending due to moral hazard, and assets are bank-specific. Surplus banks ration lending and instead purchase assets from needy banks, an inefficiency more acute during financial crises. A central bank acting as a lender-of-last-resort can ameliorate this inefficiency provided it is prepared to extend potentially loss-making loans or is better informed than outside markets, as might be the case if it also performs a supervisory role. This rationale for central banking finds support in historical episodes. (JEL E58, G01, G21, G28, L13, N21)
Acharya, Viral V., Denis Gromb, and Tanju Yorulmazer.
"Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking."
American Economic Journal: Macroeconomics,
Central Banks and Their Policies
Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
Financial Institutions and Services: Government Policy and Regulation
Oligopoly and Other Imperfect Markets
Economic History: Financial Markets and Institutions: U.S.; Canada: Pre-1913