Adrian Penalver (Banque de France) – Banks and the rational credit cycle

The interbank lending market is one of the foundation of modern financial markets. It allows the flow of liquidities between banks in order to meet temporary and localized liquidity needs. The rate of interbank loans is a major guide for many products traded on several OTC markets. If some models analyze how search frictions, bargaining power and risk aversion affect prices and liquidity in OTC markets, they don't endogenize the creation of relationship between banks. The dynamic of their formation is however a key feature to understand how liquidity and shocks spread through the network. We use a dataset provided by the OeNB on the interbank market structure in Austria to present the key characteristics of the formation of these relationships. We discuss the stability and persistence of some topological characteristics and show that this network has a core-periphery structure already presented in several empirical studies. Finally we propose a network formation model to explain the endogenous creation of relationships in which banks, subject to liquidity shocks, form links with potential lenders and bargain over the rate. In this model persistent relationships are used by the banks to hedge liquidity risk.