Are banks peer disciplined? Evidence from post-crisis Russia

Market discipline is usually studied in the retail or the corporate deposit markets, while the interbank loan market is disregarded. Banks' abilities to exert market discipline are taken for granted, as they are expected to have the expertise to assess correctly the riskiness of other banks. However, the “crises of trust” (as one in 2004 in Russia) create some doubts as to whether efficient peer monitoring and peer discipline exist: the interbank loan market may be frozen in response to external information which is unrelated to the banks’ current reliability. This seems to be one of the reasons for the interbank loan markets being extremely fragile during periods of financial instability, undermining the smooth functioning of the whole banking system, as banks are tightly interconnected. We provide some evidence for market discipline in the Russian interbank market. We show that the only disciplinary mechanism that functions is a price-based one: more reliable banks enjoy lower interest rates. The quantitative discipline functions only for the largest borrowers. In general, decisions on credit limits are based not on changes in another bank’s riskiness but on other information like reputation, soft information or public announcements that may be even unrelated to a particular bank.