Credit market competition and liquidity crises

We develop a model where banks invest in reserves and loans, and trade loans on the interbank market to deal with liquidity shocks. Two types of equilibria emerge, depending on the degree of credit market competition and the level of aggregate liquidity risk. In one equilibrium, all banks keep enough reserves and remain solvent. In the other, some banks default with positive probability. The latter equilibrium exists when competition is not too intense and high liquidity shocks are not too likely. The model delivers several implications concerning the severity of crises and credit availability along the business cycle.