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By Ulrike Neyer

The construction of a unmarried financial foreign money and a unmarried financial coverage within the euro quarter has confronted remarkable demanding situations, between them the layout of compatible financial coverage tools. This booklet evaluates financial coverage tools of the Eurosystem opposed to a few requisites. For doing so, a theoretical version framework is built which brings jointly the financial coverage actions of a vital financial institution and the liquidity administration of banks contemplating the most features and institutional beneficial properties of the euro region. major result of this research are that various bills of acquiring liquidity at once from the valuable financial institution can clarify the lifestyles of an interbank industry within the euro quarter and the optimistic unfold among the interbank industry fee and the repo cost; that the redecorate of the Eurosystem’s tools in 2004 needs to be evaluated absolutely and additional switch to the minimal reserve process may increase the pliability of economic coverage within the euro area.

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1 Heterogeneous Banking Sector Looking at the banking sector as a whole, we consider a continuum of measure one of isolated, price-taking banks. The crucial point is that the banks differ in their level of marginal opportunity costs of holding 38 4 Base Model K opt A 0 q q q Fig. e. q is a bank-specific cost parameter. This heterogeneity of the banking sector leads to the development of an interbank market. Banks with relatively low opportunity costs of holding collateral (q < q) borrow more liquidity from the monetary authority than they need to cover their own liquidity needs in order to place the excess liquidity in the interbank market, while banks with relatively high opportunity costs of holding collateral (q > q) cover their liquidity needs partially or totally in the interbank market.

3 Interbank Market Equilibrium 39 costs of obtaining funds at the central bank (which, therefore, have a higher reservation interbank market interest rate), a higher rate e is not possible, or to put it differently, consumer surplus cannot be captured. e. we assume that banks specialize in different business segments. 2 Equilibrium Interbank Market Rate For determining the equilibrium interbank market rate e∗ , we assume that q is distributed in the interval [0, q max ] across banks according to the density function g(q) = G (q) with G(0) = 0.

However, this would make our analysis more complex without changing our main results so that we neglect this interbank market function. In our analysis, the interbank market exists because of a heterogenous banking sector, banks differ in costs of obtaining funds from the central bank because their opportunity costs of holding collateral are different. Concerning the heterogeneity of the banking sector, we will briefly comment on two aspects: price discrimination and the survival of banks with relatively high costs.

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