Abstract
This paper examines the impact of interbank competition on liquidity risk and on the interaction between liquidity and credit risks. We first show that financial intermediation with deposit insurance may increase the impact of liquidity risk, so that intermediated loans may carry higher liquidity premia for borrowers than market-financed loans. Second, with negligible interbank competition, higher credit risk may reduce liquidity risk, so a bank's need for liquidity may also induce it to take on additional credit risk. Third, we show that Bertrand competition among banks in the loan market, introduced by outside lenders purchasing the relationship-specific liquidation skilll of the incumbent lender, has two potential effects: (i) it can improve loan liquidity, and (ii) it can make credit and liquidity risks comonotonic, thereby reducing the inclination of banks to take on excessive credit risk to cope with their liquidity needs. However, interbank competition improves loan liquidity only under some conditions. We identify conditions under which greater interbank competition increases loan liquidity and reduces each bank's overall risk, which includes credit and liquidity risks.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
