Always Look on the Bright Side? Central Counterparties and Interbank Markets during the Financial Crisis

This paper joins the literature on the growing use of central counterparties (CCPs) in interbank markets by analyzing a scarcely explored source of risk, namely that CCPs may provide riskier banks that are cut off from the bilateral segment of the market with an alternative channel to access interbank funds, thereby eluding peer monitoring and potentially increasing the risks borne by the financial system. We investigate this issue using monthly granular data on Italian banks from June 2004 to June 2013 and we find that during the global financial crisis riskier banks increased the share of their interbank funding obtained via CCPs, due to both the impact of general market uncertainty and the heightened attention to counterparty risk in the bilateral segment of the market. More tellingly, we show that, for riskier banks only, this increase was associated with a decline in the duration of bilateral relationships, indicating that longer-standing counterparties, typically those with more information, tended to withdraw from relationships with those banks. This suggests that during our sample period the pool of banks operating via CCPs may have become riskier, confirming, from a novel perspective, the importance of the policy efforts to ensure that CCPs have a proper risk-management framework.