What Determines Commercial Banks' Demand for Reserves in the Interbank Market

In this paper I analyse the determinants of commercial banks' demand for reserves in the interbank market. I first document the pattern in the Eurosystem, where banks deviate from the required reserves balance at the start of the maintenance period only to meet the requirements closer to the settlement day. Using my model I show that this behaviour can be explained by certain trade-related frictions and costs. Examples include potential extra expenses tied to large transactions or the asymmetry between the cost of borrowing and profits from lending. I also find that borrowing decisions can be largely unaffected by current liquidity, which has important implications for the implementation of central bank monetary policy: in order to influence the level of interest rates, the central bank must focus on controlling market expectations. Keywords: money markets, EONIA, liquidity effect JEL classification numbers: E52, E58, E43