Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk

Heider, Florian; Hoerova, Marie; Holthausen, Cornelia

doi:10.2139/ssrn.1343606

Cited by 247 publications

(192 citation statements)

References 46 publications

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“…Bhattacharya and Gale (1987), Bhattacharya and Fulghieri (1994), Freixas et al (2000) and Allen and Gale (2000), for instance, extend the standard banking model of Diamond and Dybvig (1983) to a multi bank setting and study how the structure, efficiency and resilience of the interbank market is affected if banks' idiosyncratic liquidity needs are private information. Rochet and Tirole (1996), Freixas and Holthausen (2005), Freixas and Jorge (2008), and Heider et al (2009) model the implications that asymmetric information of borrowers' credit risk has on tiering in the interbank market as well as on credit risk spreads and potential freezes in the unsecured interbank market. 3 However, none of these theoretical papers studies how the repeated interaction between banks affects these informational asymmetries and their implications.…”

Section: Related Literaturementioning

confidence: 99%

Relationship Lending in the Interbank Market and the Price of Liquidity

Bräuning

Fecht

2016

Review of Finance

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This paper empirically investigates the effect of interbank relationship lending on banks' access to liquidity. Our analysis is based on German interbank payment data which we use to create a panel of unsecured overnight loans between 1079 distinct borrower-lender pairs. The data shows that banks rely on repeated interactions with the same counterparties to trade liquidity. For the price of liquidity, we find that in the run-up to the recent financial crisis of 2007/08 relationship lenders charged already higher interest rates to their borrowers after controlling for other bank specific characteristics and general market conditions. By contrast, during the crisis borrowers paid on average lower rates to their relationship lenders compared to spot lenders. The observed interest rate differences are statistically and economically significant and in line with theory that relationship lenders have private information about the creditworthiness of their close borrowers.

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Section: Related Literaturementioning

confidence: 99%

Relationship Lending in the Interbank Market and the Price of Liquidity

Bräuning

Fecht

2016

Review of Finance

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“…11 In the "jump start" equilibrium, a small injection of reserves by central banks induces banks to hoard liquidity since the anticipated rise in collateral value is too small to justify lending; hence the need for forceful lending. Heider et al (2009) build a model of interbank markets in the spirit of Diamond and Dybvig (1983). The interbank market distributes liquidity from banks with exmarket failure, it may not make sense to provide liquidity at a penalty rate over the market since no particular institution is benefiting relative to others.…”

Section: Rationale Of the Fed's Responses To The Crisismentioning

confidence: 99%

“…Alternatively, the arbitrage trade may have suddenly turned risky as previously lowrisk trading counterparties became insolvent. Indeed, after the Lehman bankruptcy, counterparty risk and its dispersion (an important variable in Heider et al 2009) became important determinants of CIP deviations and the Fed's supply of dollars was , 2007, , until March 30, 2009 less effective in reducing the deviations. In general, these results indicate that both liquidity and credit risks are responsible for the failure of arbitrage, but that the contribution of each has varied over time.…”

Section: Effectiveness Of the Fed's Programs: Empirical Evidencementioning

confidence: 99%

Liquidity risk, credit risk, and the federal reserve’s responses to the crisis

Sarkar

2009

Financ Mark Portf Manag

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In responding to the severity and broad scope of the crisis, the Federal Reserve (the Fed) has aggressively utilized both traditional monetary policy instruments, as well as innovative tools to provide liquidity. In this paper, the Fed's actions are examined in light of the evolution of risk during the crisis. The empirical evidence supports the Fed's views on the primacy of liquidity constraints in the earlier stages of the crisis and the increased prominence of counterparty credit risk as the crisis evolved in 2008. I conclude that an understanding of the prevailing risk environment is necessary to evaluate when central bank programs are likely to be effective and under what conditions the programs might cease to be necessary.

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“…This creates fear among market participants who start to hoard excess liquidity as a precautionary measure, leading to further liquidity shortage -as happened during the days following the Lehman bankruptcy. Heider et al (2015) provide evidence of interbank market freeze during the 2008 financial crisis while Acharya et al (2011) does so for the case of repo markets. iv.…”

Section: Bank-bank Linkagementioning

confidence: 94%