Inefficiency of Bilateral Bargaining in Inter-Bank Markets

29 Pages Posted: 8 May 2009 Last revised: 12 May 2009

See all articles by Indrajit Mallick

Indrajit Mallick

Centre for Studies in Social Sciences Calcutta

Date Written: May 4, 2009

Abstract

Many countries have inter-bank 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 (inter-bank) loan. This paper characterizes such bilateral bargaining for loans between banks under asymmetric information and shows that bargaining outcomes maybe inefficient. The paper 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. Inter-temporal issues examined in this paper reveals that repeated interaction could create distorting effects through reciprocal contracts. Both cases are shown to require active liquidity management by the regulatory authority in order to restore the first best allocation.

Keywords: liquidity distribution, asymmetric information, interbank markets

JEL Classification: E500, G100, G 200

Suggested Citation

Mallick, Indrajit, Inefficiency of Bilateral Bargaining in Inter-Bank Markets (May 4, 2009). Available at SSRN: https://ssrn.com/abstract=1398768 or http://dx.doi.org/10.2139/ssrn.1398768

Indrajit Mallick (Contact Author)

Centre for Studies in Social Sciences Calcutta ( email )

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