This paper considers credit default swaps (CDSs) used for the transfer of credit risk within the banking sector. The banks' motive to conclude these CDS contracts is to improve the diversification of their credit risk. It is shown that these CDSs reduce the stability of the banking sector in a recession. However, during a boom or in periods of moderate economic up-or downturn, they may reduce this stability. The main reasons behind these negative impacts are firstly, that banks are induced to increase their investment in an illiquid, risky credit portfolio, and secondly, that these CDSs may create a possible channel of contagion.
We analyse the impact of overnight interbank market frictions on bank loan supply when banks face idiosyncratic liquidity risk and discuss resulting implications for monetary policy implementation. Sufficiently pronounced interbank market frictions imply that banks hold positive or negative precautionary liquidity. Holding positive (negative) precautionary liquidity means that banks hold more (less) liquidity than they expect to need. As holding precautionary liquidity is costly, interbank market frictions negatively influence bank loan supply. However, by means of its standing facilities, the central bank not only offers an alternative to using the interbank market but also determines the costs of friction-induced holdings of positive or negative precautionary liquidity. Therefore, the facilities allow the central bank to influence banks' expected liquidity costs, and thereby their loan supply, so that interbank market frictions need not be an impediment to monetary policy transmission.
This paper develops a theoretical model which replicates main institutional features of the euro overnight interbank market and the Eurosystem's operational framework which has been in place since September 2008. Main ingredients of the model are frictions in form of participation costs in the interbank market, a refinancing operation with unlimited liquidity supply and two standing facilities offered by the central bank. The model can explain several stylized facts observed during the financial crisis as the decline in interbankborrowing and the interbank rate, the increased borrowing from the Eurosystem and the strong recourse to its deposit facility. Furthermore, we discuss some policy implications.
Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. www.econstor.eu JEL classification: E52, E58, G01, G21
Terms of use:
Documents in EconStor may
This paper develops a theoretical model which replicates main institutional features of the euro overnight interbank market and the Eurosystem's operational framework which has been in place since September 2008. Main ingredients of the model are frictions in form of participation costs in the interbank market, a refinancing operation with unlimited liquidity supply and two standing facilities offered by the central bank. The model can explain several stylized facts observed during the financial crisis as the decline in interbank borrowing and the interbank rate, the increased borrowing from the Eurosystem and the strong recourse to its deposit facility. Furthermore, we discuss some policy implications.
scite is a Brooklyn-based organization that helps researchers better discover and understand research articles through Smart Citations–citations that display the context of the citation and describe whether the article provides supporting or contrasting evidence. scite is used by students and researchers from around the world and is funded in part by the National Science Foundation and the National Institute on Drug Abuse of the National Institutes of Health.