how bank loans work, page-25

hippo

"One thing I am not clear on is the extent to which banks borrow from each other and the central bank at the officially-targeted overnight interest rate."

There is a short term interbank market in ES cash between the banks with daily volumes in the tens of billions. The RBA regularly intervenes to withdraw and inject liquidity to offset the movement of cash in and out of the system associated with government flows (tax payments or government expenditure). The pricing of these transactions determines the official RBA cash rate.

The interbank transactions are predominantly over night (one day) arrangements, usually reversed the next day. The RBA transactions have an average duration of 7 days.

The short duration of these loans (often in the form of repo agreements) is not consistent with your rehyphonation model. The banks do not hold the liabilities long enough to lever up in the way you imagine. NAB could be borrowing from Westpac today, and repaying the loan tomorrow and lending to CBA on the same day - all depending on their clearing flows.

Banks will only lend to one another on a uncommitted short term basis.. Given their cost of capital, to deal on any other basis would be inherently unprofitable.