Precautionary Reserves and the Interbank Market

Abstract

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. Terms of use: Documents in AbstractLiquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using data on intraday account balances held by banks at the Federal Reserve and Fedwire interbank transactions to estimate all overnight fed funds trades, we present empirical evidence on banks' precautionary hoarding of reserves, their reluctance to lend, and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Our theoretical results show that banks rationally hold excess reserves intraday and overnight as a precautionary measure against liquidity shocks. Moreover, the intraday fed funds rate can spike above the discount rate and crash to near zero. Apparent anomalies during the financial crisis may be seen as stark but natural outcomes of our model of the interbank market. The model also provides a unified explanation for several stylized facts and makes new predictions for the interbank market.

A Network View on Interbank Market Freezes

“…Our analysis of the term segment of the interbank market complements both papers and we show that the market dynamics in the overnight segment cannot be seen independently of the term segments. Our findings are thus well in line with Ashcraft, McAndrews, and Skeie (2011), who show that overnight money market lending in the fed funds and Eurodollar market increased during the early phase of the crisis and held up well, even after the failure of Lehman Brothers. Moreover, our observations for the longer-term euro area interbank market are consistent with the findings of Kuo, Skeie, Vickery, and Youle (2013) for the US money market, who suggest that lending volumes generally fell, especially for maturities beyond the one-month bucket while term spreads increased.…”

A Network View on Interbank Market Freezes

“…Our analysis of the term segment of the interbank market complements both papers and we show that the market dynamics in the overnight segment cannot be seen independently of the term segments. Our findings are thus well in line with Ashcraft et al (2011), who show that overnight money market lending in the fed funds and Eurodollar market increased during the early phase of the crisis and held up well, even after the failure of Lehman Brothers. Moreover, our observations for the longer-term euro area interbank market are consistent with the findings of Kuo networks.…”

Excess reserves, monetary policy and financial volatility

“…It is important to note that because there is a perfectly elastic supply of liquidity, the bank is not subject to (random) withdrawal risk which has been a key factor in reserve management models. 11 Therefore, increased uncertainty about the size of cash withdrawals does not in ‡uence the quantity of excess bank reserves in this model.…”