Secured and Unsecured Interbank Markets: Monetary Policy, Substitution and the Cost of Collateral

We study the substitution between secured and unsecured interbank markets. Banks are competitive andsubject to reserve requirements in a corridor rate system with deposit and lending facilities. Banks face counterparty risk in the unsecured market and incur an opportunity cost to pledge collateral. The model provides insights on interest rates, trading volumes and substitution between the two markets. Using transaction data on the Euro money market, we provide new empirical findings that the model accounts for: (i) borrowing banks are active on both markets even when their collateral constraint is not binding, (ii) secured interest rates may fall below the deposit facility rate. We derive and empirically test predictions on how conventional and unconventional monetary policies impact interbank markets, depending on whether marketable collateral is purchased or not.