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Title: Credit Market Competition and Liquidity Crises

Author(s): Elena Carletti and Agnese Leonello

Publication Date: January 2013

Keyword(s): default, Interbank market and price volatility

Programme Area(s): Financial Economics

Abstract: We develop a model where banks invest in reserves and loans, and face aggregate liquidity shocks. Banks with liquidity shortage sell loans on the interbank market. Two equilibria emerge. In the no default equilibrium, all banks hold enough reserves and remain solvent. In the mixed equilibrium, some banks default with positive probability. The former exists when credit market competition is intense. The latter emerges when banks exercise market power. Thus, competition is beneficial to financial stability. The structure of liquidity shocks affects the severity and the occurrence of crises, as well as the amount of credit available in the economy.

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Bibliographic Reference

Carletti, E and Leonello, A. 2013. 'Credit Market Competition and Liquidity Crises '. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9311