Liquidity Risk,Bank Networks,and the Value of Joining the Federal Reserve System

Reducing systemic liquidity risk related to seasonal loan demand was one reason for founding the Federal Reserve System. Nevertheless, less than 8% of state‐chartered banks joined the Fed in its first decade. Banks facing high liquidity risk from seasonal loan demand were more likely to join the Fed in its first decade. We also find evidence consistent with the notion that banks could obtain some indirect access to the discount window through interbank transfers. Some banks apparently joined the Fed to pass through discount window liquidity to other banks via the interbank network.  Joining the Fed increased member banks’ lending.     

Interbank market failure and macro-prudential policies

This paper analyses the effects of several macro-prudential policy measures on the banking sector and its linkages to the macroeconomy. We employ a dynamic general equilibrium model with sticky prices, in which banks trade excess funds in the interbank lending market. We find that an increase in the liquidity requirement effectively reduces the impact of an interbank shock on the real and financial sector, while an increased capital requirement propagates only through nominal variables as inflation and interest rates. We conclude that stricter liquidity measures which limit inside money creation, dampen the severity of a breakdown in interbank lending. Targeting interbank financing directly through liquidity measures along with a moderate capital requirement generates lower welfare losses. We thereby provide a comprehensive rationale in favor of the regulatory measures in Basel III.     

Network reactions to banking regulations

Optimal regulatory restrictions on banks have to solve a delicate balance. Tighter regulations reduce the likelihood of banks’ distress. Looser regulations foster the allocation of funds toward productive investments. With multiple banks, optimal regulation becomes even more challenging. Banks form partnerships in the interbank lending market in order to face liquidity needs and to meet investment possibilities. We show that the interbank network can suddenly collapse when regulations are pushed beyond a critical level, with a discontinuous increase in systemic risk as the cross-insurance of banks collapses.     

On the efficiency of bilateral interbank insurance

This paper studies banks’ incentives to engage in liquidity cross-insurance. In contrast to previous literature we view interbank insurance as the outcome of bilateral (and non-exclusive) contracting between pairs of banks and ask whether this outcome is socially efficient. Using a simple model of interbank insurance we find that this is indeed the case when insurance takes place through pure transfers. This is even though liquidity support among banks sometimes breaks down, as observed in the crisis of 2007–2008. However, when insurance is provided against some form of repayment (such as is the case, for example, with credit lines), banks have a tendency to insure each other less than the socially efficient amount. We show that efficiency can be restored by introducing seniority clauses for interbank claims or through subsidies that resemble government interbank lending guarantees.     

Bank-to-bank lending channel and the transmission of bank liquidity shocks: Evidence from France

Good liquidity is essential for the banking system to function properly and supply credit to the real sector. However, several banks all over the world face large shocks to their liquidity supply due to numerous factors. This study contributes to the literature on the transmission of liquidity shocks by investigating the bank-to-bank lending behavior of French banks during the global financial crisis (2008 and 2009). In addition, we examine the factors strongly influencing the liquidity of the interbank deposits market. First, using a fixed-effects model on a sample of 85 French banks for the period from 2005 to 2010, we find that the deposits channel plays an important role in the transmission of liquidity shocks across the banking system. Second, we use difference-in-difference methodology to study the effects of liquidity shock on bank lending. Our results show that French banks reduced their bank-to-bank lending significantly during the financial crisis period. Moreover, our results suggest that the reduction could have been due to deposit activities.     

Mapping the UK interbank system

We present new evidence on the structure of interbank connections across key markets: derivatives, marketable securities, repo, unsecured lending and secured lending. Taken together, these markets comprise two networks: a network of interbank exposures and a network of interbank funding. Network structure varies across and within these two networks, for reasons related to markets’ different economic functions. Credit risk and liquidity risk therefore propagate in the interbank system through different network structures. We discuss the implications for financial stability.     

Liquidity Coinsurance and Bank Capital

Banks can deal with their liquidity risk by holding liquid assets (self‐insurance), by participating in interbank markets (coinsurance), or by using flexible financing instruments, such as bank capital (risk sharing). We use a simple model to show that undiversifiable liquidity risk, that is, the liquidity risk that banks are unable to coinsure on interbank markets, represents an important risk factor affecting their capital structures. Banks facing higher undiversifiable liquidity risk hold more capital. We posit that, empirically, banks that are more exposed to undiversifiable liquidity risk are less active on interbank markets. Therefore, we test for the existence of a negative relationship between bank capital and interbank market activity and find support in a large sample of U.S. commercial banks.     

Interbank relationship lending revisited: Are the funds available at a similar price?

Under the market discipline hypothesis, monitoring by interbank lenders may induce changes in either the price or availability of new interbank funds to borrower banks. However, the presence of interbank relationship lending has been evaluated based on the availability of funds only—disregarding their price. We revisit relationship lending in unsecured interbank lending markets by simultaneously evaluating the availability and price of funds. We calculate the survival ratio of networks containing the price of daily interbank lending in Colombia from 2014 to 2020. Under this framework, an interbank relation survives from one day to the next if the funds are available at a price that does not increase too much; that is, either a halt in interbank funding or a sizeable increase in the price of interbank funding mark a break in the relation between two banks. We find that about 38 percent of relations in the Colombian unsecured interbank lending market survive from one day to the next. Therefore, from a comprehensive market discipline perspective, we find evidence of interbank relationship lending in Colombia.     

Interbank contagion risk in China under an ABM approach for network formation

This paper uses an agent-based model to construct an interbank network for the Chinese interbank market using a sample of 299 commercial banks from 2014 to 2019. We analyze the importance and vulnerability of banks using the DebtRank algorithm. Our results show that the Chinese interbank market bears a certain level of systemic risk, especially among lower-tiered banks. The results also show a bank is more vulnerable if it has a higher interbank lending ratio and greater financial connectivity. Meanwhile, a bank is more influential if it has a larger net worth and greater financial connectivity.     

Liquidity Crunch in the Interbank Market: Is it Credit or Liquidity Risk, or Both?

The interplay between liquidity and credit risks in the interbank market is analyzed. Banks are hit by idiosyncratic random liquidity shocks. The market may also be hit by bad news at a future date, implying the insolvency of some participants and creating a lemons problem; this may end up with a gridlock of the interbank market at that date. Anticipating such possible contingency, banks currently long of liquidity ask a liquidity premium for lending beyond a short maturity, as a compensation for the risk of being short of liquidity later and being forced to liquidate some illiquid assets. When such premium gets too high, banks currently short of liquidity prefer to borrow short term. The model is able to explain some stylized facts of the 2007–2009 liquidity crunch affecting the money market at the international level: (i) high spreads between interest rates at different maturities; (ii) “flight to overnight” in traded volumes; (iii) ineffectiveness of open market operations, leading the central banks to introduce some relevant innovations into their operational framework.     

Systemic liquidity shortages and interbank network structures

This paper aims to shed light on the systemic nature of liquidity risk and to propose a method for calculating systemic liquidity shortages. Our method incorporates not only direct liquidity shortages but also indirect liquidity shortages due to the knock-on effects through interbank linkages. We perform a simulation with a simple banking system model and find that a deficit bank can mitigate a liquidity shortage by holding more claims on a surplus bank. Meanwhile, a greater imbalance in liquidity positions across banks tends to aggravate the liquidity shortage of a deficit bank. According to comparative analysis between different types of network structures, a core-periphery network with a deficit money center bank gives rise to the highest level of systemic liquidity shortage, and a banking system becomes more vulnerable to liquidity shocks as its interbank network becomes more ill-matched.     

(In)Efficient Interbank Networks

We study the efficiency properties of the formation of an interbank network. Banks face a trade-off by establishing connections in the interbank market. On the one hand, banks improve the diversification of their liquidity risk and therefore can obtain a higher expected payoff. On the other hand, banks not sufficiently capitalized have risk-shifting incentives that expose them to the risk of bankruptcy. Connecting to such risky banks negatively affects expected payoff. We show that both the optimal and the decentralized networks are characterized by a core-periphery structure. The core is made of the safe banks, whereas the periphery is populated by the risky banks. Nevertheless, the two network structures coincide only if counterparty risk is sufficiently low. Otherwise, the decentralized network is underconnected as compared to the optimal one. Finally, we analyze mechanisms that can avoid the formation of inefficient interbank networks.     

Optimal liquidity management and bail-out policy in the banking industry

We characterize the profit-maximizing reserves of a commercial bank, and the generated probability of a liquidity crisis, as a function of the penalty imposed by the Central Bank, the probability of depositors' liquidity needs, and the return on outside investment opportunities. We demonstrate that banks do not fully internalize the social cost associated with the bail-out policy if the liquidity needs of individuals are correlated, and that competitive interbank markets will induce banks to raise their reserves under reasonable conditions. The marginal benefits from an interbank market decrease as the correlation between the liquidity shocks of banks increases.     

Can banks default overnight? Modelling endogenous contagion on the O/N interbank market

We propose a new model of the liquidity-driven banking system focusing on overnight interbank loans. This significant branch of the interbank market is commonly neglected in the banking system modelling and systemic risk analysis. We construct a model where banks are allowed to use both the interbank and the securities markets to manage their liquidity demand and supply as driven by prudential requirements in a volatile environment. The network of interbank loans is dynamic and simulated every day. We show how the intrasystem cash fluctuations alone, without any external shocks, may lead to systemic defaults, and what may be a symptom of the self-organized criticality of the system. We also analyze the impact of different prudential regulations and market conditions on the interbank market resilience. We confirm that the central bank’s asset purchase programmes, limiting the declines in government bond prices, can successfully stabilize banks’ liquidity demands. The model can be used to analyze the interbank market impact of macroprudential tools.     

Complexity, concentration and contagion

This paper develops a network model of interbank lending in which unsecured claims, repo activity and shocks to the haircuts applied to collateral assume centre stage. We show how systemic liquidity crises of the kind associated with the interbank market collapse of 2007–2008 can arise within such a framework, with funding contagion spreading widely through the web of interlinkages. Our model illustrates how greater complexity and concentration in the financial network may amplify this fragility. The analysis suggests how a range of policy measures – including tougher liquidity regulation, macro-prudential policy, and surcharges for systemically important financial institutions – could make the financial system more resilient.     

Does Interbank Borrowing Reduce Bank Risk?

In this paper we investigate whether banks that borrow from other banks have lower risk levels. We concentrate on a large sample of Central and Eastern European banks that allows us to explore the impact of interbank lending when exposures are long term and interbank borrowers are small banks. The results of the empirical analysis generally confirm the hypothesis that long-term interbank exposures result in lower risk of the borrowing banks.     

Funding Modes of German Banks: Structural Changes and their Implications

We investigate the funding modes of German banks and the implications for lending and profitability during 1992–2002. We find that at many banks, deposits from customers decrease in relative terms while interbank liabilities increase as a source of funding. We cannot detect a negative impact of the relative decline in deposits on lending. The decreasing ability of banks to collect deposits and the substitution of deposits by interbank liabilities unfavorably affects the net interest result of banks that exhibit a deposit deficit, especially savings banks. Our findings indicate a structural lengthening of the intermediation chain, which has broader implications for the functioning and stability of the financial system.     

Interbank connections,contagion and bank distress in the Great Depression✰

Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were vulnerable to closures of their correspondents and their respondents. Further, banks were less responsive to network liquidity risk in their management of cash and capital buffers after the Federal Reserve was established, suggesting that banks expected the Fed to reduce that risk. The Fed's presence weakened incentives for the most systemically important banks to maintain capital and cash buffers against liquidity risk, and thereby likely contributed to the banking system's vulnerability to contagion during the Depression.     

Money and liquidity in financial markets

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests on the stock market are supportive. Tighter interbank markets are associated with relatively more volume in more liquid stocks; selling pressure, especially in more liquid stocks; and transitory negative returns. We control for market-wide uncertainty and in the process also contribute to the literature on portfolio rebalancing. Our general point is that money matters in financial markets.     

货币政策对银行间市场流动性影响效应的实证研究及启示

银行间货币市场是央行实施货币政策的重要平台，研究货币政策对银行间市场流动性的影响对于完善商业银行日常流动性管理具有重要意义。文章在设定银行间市场流动性测度指标与梳理货币政策工具对市场流动性的影响机制的基础上，分别使用事件分析法和时间序列模型对不同政策工具的影响效应进行实证分析，得出相关分析结论，并总结其对于完善商业银行日常流动性管理的启示。