An Interbank Network Determined by the Real Economy

As a means of payment, bank liability circulates in a cycle. A fraction of one bank's liability naturally flows out to another, creating a network of interbank connections. We demonstrate how this network is determined by the production technologies, the resources distribution and the Input-Output network of the real economy. We find banks with a smaller outflow fraction see their funding costs less dependent on the interbank interest rate; the heterogeneity in banks' outflow fraction causes lending ine¢ ciency; and the identities of depositors and borrowers matter. These results will not arise if banks are modelled as intermediaries of loanable funds.