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...

We develop a model where banks invest in reserves and loans, and face aggregate liquidity shocks. Banks with liquidity shortage sell loans on the interbank market. Two equilibria emerge. In the no default equilibrium, all banks hold enough reserves and remain solvent. In the mixed equilibrium,...