Interbank Networks in the Shadows of the Federal Reserve Act
70 Pages Posted: 20 Nov 2020
Date Written: August 2020
Central banks offer public liquidity to banks (through lending facilities and promises of bailouts) with the intention of stabilizing the financial system. However, shadow banks may receive access to that liquidity through an interbank system. We build a model that shows that the public liquidity provision of the Federal Reserve Act increased systemic risk through three channels: by reducing aggregate liquidity, by expanding the whole-sale funding market, and by crowding out the private insurance that had previously served to smooth cross-regional liquidity shocks. Then, using unique data on Virginia state banks that contain detailed disaggregated information on interbank deposits and short-term funds, we show that the introduction of the Federal Reserve System changed the structure and nature of the overall interbank network in ways that are consistent with the model.
Keywords: Dual Banking System, Federal Reserve Act, Shadow Banking, Interbank Networks, Systemic Risk
JEL Classification: G20, E50, N22
Suggested Citation: Suggested Citation