Inefficiency of bilateral bargaining in interbank markets |
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| Institution: | 1. Department of economics, University of Milan Bicocca, Piazza dell’Ateneo Nuovo 1, 20126, Milan, Italy;2. CEREC, Université Saint-Louis - Bruxelles, Boulevard du Jardin Botanique 43, 1000, Brussels, Belgium;3. CORE, Université catholique de Louvain, Voie du Roman Pays 34, Louvain-la-Neuve B-1348, Belgium;1. University of Wisconsin—Madison, Wisconsin School of Business, 5259 Grainger Hall, 975 University Avenue, Madison, WI 53706, USA;3. Nova School of Business and Economics, Campus de Campolide, 1099–032 Lisboa, Portugal;4. Center for Economic Policy Research (CEPR), UK |
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| Abstract: | Many countries have interbank markets that are over the counter (OTC) instead of exchange mediated. In OTC systems, bilateral bargaining takes place over the rate of interest on the (interbank) loan. This article characterizes such bilateral bargaining for loans between banks under asymmetric information and shows that bargaining outcomes maybe inefficient. The article suggests two sources of inefficiency. In a one-period model, bargaining between two banks may fail due to incomplete information even if gains to trade exist. Intertemporal issues examined in this article reveal that repeated interaction could create distorting effects through reciprocal contracts. Both cases are shown to require active liquidity management by the regulatory authority to restore the first best allocation. |
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