Relationship Lending in the Interbank Market and the Price of Liquidity
The previous literature has argued that private information about counterparty risk plays a crucial role in enhancing efficiency of the liquidity allocation in the interbank lending market. Despite the interbank market’s importance for financial stability and monetary policy, due to a lack of transaction-level data, there is little empirical evidence on the precise role that private information plays in the allocation and pricing of credit. With a unique dataset composed of a daily panel of unsecured overnight loans between 1,079 distinct pairs of German banks, the authors use different sample selection models for the availability and pricing of credit from March 2006 through mid-November 2007, a period which in a smaller way mimicked the larger constrained credit conditions present in 2008 with the onset of the global financial crisis. In particular, the authors determine if bilateral lending relationships help mitigate search frictions and overcome informational asymmetries related to uncertainty about counterparty credit risk.