Modelling Relationship Lending in the Overnight interbank market

September 10, 2012

Abstract The interbank lending market has a large aect and the relationship lending have an important role to do that. In this paper, we use the Agent-Based model to research these relationships in three aspects: i) the eect of liquidity to relationship lending, ii) Eect of relationship lending to interbank market stability, iii) The eect of shocks to these relationships. For general, we divide the bank into two group: homogeneous and heterogeneous with public or private informations about the borrowers. The model should be able to predict the decisions of banks to leave the interbank market. Based on their result, we will propose new perspectives of modelling these interbank relationships. Context research: After the crisis in 2007, the preferential lending grows quickly. Most of the research focused on the analysis of bank-rm relationships of preferential lending. A interesting question is that how those inter-bank relationships lending may inuence market. Thus we want to determine it under dierent settings: (1) mechanisms: an over-the-counter market (where bids are private information) and transparent market (where bids are public information), (2) behavoiour of the bank: homogeneous or heterogeneous and (3) information quality: symmetric (or perfect) of asymmetric. In addition, the interbank relationship can be used to test market stability, especially under stressed conditions.

The Overall Model

Numbers of banks is N . Discretized time t = 1, 2, . . . , T . are borrowers, and 1 are lenders. i refers to borrower and j to lender. i,j,t kit = kjt = 1: all the money requests are set equal to 1 (we dont consider volumes).

Model 1: market with public bids(PB) and homogeneous banks(HOB)

Probability of default P (i) = p. Neutral rate : r = dp p rdb rijt if they have been selected by a lender Borrowers prots: rdb rdw if they have not been selected by a lender
r

Model 2: market with PB and heterogeneouss banks(HB)

Lender rank the borrowers oer according to their expected prot L = ri pi , where pi = pg if i G and pi = pb if i B i Neutral rate: rb = rg pg with rg = b
p rdb pg .

L L L Expected prot from the trade: L (i) = ri pg Pg (i, t) + ri pb Pb (i, t). Here, Pg (i, t) = L P L ( i G| j F (t)), Pb (i, t) = P L ( i B| j F (t)) of a given borrower to be good or bad. Lenders select a borrower with a probability pm : ij

pm ij

e (i) j (i) iO(j) e

j L j L i O(j): Satisfy max(Pg (i, t); Pg (i, t)) > K or max(Pb (i, t); Pb (i, t)) > K
L

Screening cost: = 0 (1 LP Ii,j,t ) with LP Ii,j,t =

l=1,l (1)N L j=1

lij lij

l=1,l

j j j Pg (i, t) = Pg (i, t0 ) min(0.5, er(tt0 ) ) + (1 Pg (i, t0 )) min(0.5, er(tt0 ) )

where t0 is the time at which the lenders has paid the screening cost.

Model 3: market with private bids(PrB) and HOB

Problem of borrower i: max{E(rel,it ), E(search,it )} Borrower payo: r,q = rdb rijt q rdb rdw if they have been selected by a lender if they have not been selected by a lender

Model 4: market with PrB and HB

Lenders j prots: L = ri,j pi j,i