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The interbank market after the financial turmoil: squeezing liquidity in a "lemons market" or asking liquidity "on tap"

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  • Antonio De Socio

    ()
    (Bank of Italy)

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    Abstract

    After August 2007 the plumbing system that supplied banks with wholesale funding, the interbank market, failed because toxic assets obstructed the pipes. Banks were forced to squeeze liquidity in a “lemons market” or to ask for liquidity “on tap” from central banks. This paper disentangles the two components of the three-month Euribor-Eonia swap spread, credit and liquidity risk and then evaluates the decomposition. The main finding is that credit risk increased before the key events of the crisis, while liquidity risk was mainly responsible for the subsequent increases in the Euribor spread and then reacted to the systemic responses of the central banks, especially in October 2008. Moreover, the level of the spread between May 2009 and February 2010 was influenced mainly by credit risk, suggesting that European banks were still in a “lemons market” and relied on liquidity “on tap”.

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    File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td11/td819_11/en_td819/en_tema_819.pdf
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    Bibliographic Info

    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 819.

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    Date of creation: Sep 2011
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    Handle: RePEc:bdi:wptemi:td_819_11

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    Keywords: interbank markets; credit risk; liquidity risk; financial crisis; Euribor spread.;

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