The interbank market after the financial turmoil: squeezing liquidity in a "lemons market" or asking liquidity "on tap"
AbstractAfter 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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Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 819.
Date of creation: Sep 2011
Date of revision:
interbank markets; credit risk; liquidity risk; financial crisis; Euribor spread.;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-11-21 (All new papers)
- NEP-BAN-2011-11-21 (Banking)
- NEP-CBA-2011-11-21 (Central Banking)
- NEP-MAC-2011-11-21 (Macroeconomics)
- NEP-MON-2011-11-21 (Monetary Economics)
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