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Working Paper 202 - Segmentation and efficiency of the interbank market and their implication for the conduct of monetary policy

29-Apr-2014

Efficiency of the interbank market is very vital for the effective conduct of monetary policy. The interbank market plays at least three critical roles in any modern financial system that have important implications for the effectiveness of monetary policy.

First, a well-functioning interbank market acts as an effectively channel for liquidity management in the banking system. It channels liquidity from institutions with surplus funds to those in need, thus allowing for more efficient financial intermediation and more effective monetary policy implementation. Over-supply or shortfalls in commercial banks’ reserves arise from stochastic deposits and withdrawals by customers that create inter-temporal liquidity shocks in banks (Bruche and Suarez, 2010). Moreover, with an interbank market in place banks ex ante will put aside less liquidity to cushion themselves from shocks.

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