Lending Relationships in the Interbank Market

Abstract

This paper is an empirical study of lending relationships among banks in the interbank market. We use a unique data set to construct a dynamic measure of relationships, namely the intensity of trading volume between the lender and borrower, as a percentage of their trading volume with all market participants, in the recent past. We find that relationships allow market participants to obtain insurance against a shortage of funds during the reserve maintenance period. We also find evidence that relationships tend to be established between banks whose liquidity shocks are less correlated, for whom the gains from the relationship are also larger. These results support the view that relationships play an important role in promoting stability of the Interbank Market.