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Bargaining power and outside options in the interbank lending market

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  • Abbassi, Puriya
  • Bräuning, Falk
  • Schulze, Niels

Abstract

We study the role of bargaining power and outside options for the pricing of over-the-counter interbank loans using a bilateral Nash bargaining model and test the model predictions with detailed transaction-level data from the euro-area interbank market. We find that lender banks with greater bargaining power over their borrowers charge higher interest rates, while the lack of alternative investment opportunities for lenders reduces bilateral interest rates. Moreover, we find that lenders that are not eligible to earn interest on excess reserves (IOER) lend funds below the IOER rate to borrowers with access to the IOER facility, which in turn put these funds in their reserve accounts to earn the spread. Our findings highlight that this persistent arbitrage opportunity is not a result of the mere lack of alternative outside options of some lenders, but it crucially depends on their limited bilateral bargaining power, leading to a persistent segmentation of prices in the euro interbank market. We examine the implications of these findings for the transmission of euro-area monetary policy.

Suggested Citation

  • Abbassi, Puriya & Bräuning, Falk & Schulze, Niels, 2017. "Bargaining power and outside options in the interbank lending market," Discussion Papers 31/2017, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdps:312017
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    Cited by:

    1. Abbassi, Puriya & Bräuning, Falk, 2018. "The pricing of FX forward contracts: Micro evidence from banks' dollar hedging," Discussion Papers 42/2018, Deutsche Bundesbank.
    2. Müller, Alexander & Paulick, Jan, 2020. ""The devil is in the details, but so is salvation": Different approachesin money market measurement," Discussion Papers 66/2020, Deutsche Bundesbank.

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    More about this item

    Keywords

    bargaining power; over-the-counter market; monetary policy; money market segmentation;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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