Exposure to interbank market and risk-taking by Mexican banks

Abstract

Banks can avoid bank runs and panic using the interbank market as a type of coinsurance. Moreover, because of the possibility of losing financial assets, they theoretically have incentives to monitor their peers, borrowing in this market. This paper examines whether bank risks are explained by their exposure to the interbank market. The market discipline hypothesis suggests that bankers are well equipped to monitor their peers, and the interbank borrowing is par excellence an uninsured deposit. Consequently, banks with a larger exposure to the interbank market should present strong bank fundamentals. Using a sample of 37 Mexican banks, from December 2008 to September 2012, and dynamic panel models based on the SYS GMM estimator, I did not find evidence in favor of the market discipline hypothesis. These results are robust to different indicators of bank risk and exposure to interbank markets. This is a wake-up call for policymakers, who should restore market discipline in interbank operations, following the disclosure policy in Basel III.

Market discipline in the Central American banking system

“…The empirical tests consist in estimations of the offer curve of deposits based on the reduced form, given that the lack of data makes it impossible to simultaneously estimate offer and demand 1 The literature suggests that subordinated debt holders are the most interested in the monitoring of bank risk (Tovar-García, 2015). Moreover, banks supervise the risk-taking of their colleagues in the interbank market (Tovar-García, 2016a, 2016b. Additionally, market discipline can also come from the side of bank assets, that is, borrowers are also interested in monitoring bank risk and they discipline banks because they prefer to request loans from banks that are well capitalized and with quality in their assets for refinancing and signaling purposes (Tovar-García & Kozubekova, 2016).…”