While domestic interbank markets are often considered to work in an efficient way, cross-country bank lending appears to be subjected to market imperfections leading to persistent interest rate differentials. In a model where banks need to cope with liquidity shocks by borrowing or by liquidating assets, we study the scope for international interbank market integration with unsecured lending when cross-country information is noisy. We find that an equilibrium with integrated markets need not always exist, and that it coexists with one characterized by segmentation. A repo market reduces interest rate spreads and improves upon the segmentation equilibrium. However, it may destroy the unsecured integrated equilibrium.
Asymmetric information Banking theory financial integration Interbank markets