Monetary Policy Implementation in the Interbank Market

The liquidity crisis that swept through the financial markets in 2007 triggered multi-billion losses and forced buyouts of some large banks. The resulting credit crunch is sometimes compared to the great recession in the early twentieth century. But the crisis also serves as a reminder of the significance of the interbank market and of proper central bank policy in this market. This thesis deals with implementation of monetary policy in the interbank market and examines how central bank tools affect commercial banks' decisions. I answer the following questions: • What is the relationship between the policy setup and interbank interest rate volatility? (averaging reserve requirement reduces the volatility) • What can explain a weak relationship between market liquidity and the interest rate? (high reserve requirement buffer) • What determines banks' decisions on when to satisfy the reserve requirement? (market frictions) • How did the liquidity crisis that began in 2007 affect interbank market behaviour? (resulted in higher credit risk and trading frictions as well as expected liquidity shortage)