Efficiency and Bargaining Power in the Interbank Loan Market

We use data on interbank loans and the core equilibrium concept to examine the efficiency of an overnight interbank lending market, and the bargaining power of its participants. In the specific case of Canada’s Large-Value Transfer System, we show that while the market is fairly efficient, systemic inefficiency persists throughout our sample. The level of inefficiency matches distinct phases of both the Bank of Canada’s operations as well as phases of the 2007-2008 financial crisis, where more intervention implies more inefficiency. We find that bargaining power tilted sharply towards borrowers as the financial crisis progressed, and (surprisingly) towards riskier borrowers. This supports a Too-Big-To-Fail story, whereby participants continued to lend to risky banks at favorable rates without the explicit involvement of governmental authorities. ∗The views expressed here are those of the authors and should not be attributed to the Bank of Canada. We thank the Canadian Payments Association. We thank Lana Embree, Matthias Fahn, Rod Garratt, Scott Hendry, Thor Koeppl, Mariano Tappata, and James Thompson as well as seminar participants at the University of Western Ontario, the Bank of Canada workshop on financial institutions and markets, the FRBNY, and IIOC (Arlington) for comments. Any errors are our own. †Financial Stability Department, Bank of Canada; [email protected] ‡Financial Stability Department, Bank of Canada; [email protected] §Division of the Humanities and Social Sciences, California Institute of Technology; [email protected] ¶Division of the Humanities and Social Sciences, California Institute of Technology; [email protected]