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The Great Liquidity Freeze : What Does It Mean for International Banking?

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Author Info

  • Dietrich Domanski

    (Asian Development Bank Institute (ADBI))

  • Philip Turner

Abstract

In mid-September 2008, following the bankruptcy of Lehman Brothers, international interbank markets froze and interbank lending beyond very short maturities virtually evaporated. Despite massive central bank support operations and purchases of key assets, many financial markets remained impaired for a long time. Why was this funding crisis so much worse than other past major bank failures and why has it proved so hard to cure? This paper suggests that much of that answer lies in the balance sheets of international banks and their customers. It outlines the basic building blocks of liquidity management for a bank that operates in many currencies and then discusses how the massive development of foreign exchange (forex) and interest rate derivatives markets transformed banks’ strategies in this area. It explains how the pervasive interconnectedness between major banks and markets magnified contagion effects. Finally, the paper provides some recommendations for how strategic borrowing choices by international banks could make them more stable and how regulators could assist in this process.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Finance Working Papers with number 23245.

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Date of creation: Jun 2011
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Handle: RePEc:eab:financ:23245

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Keywords: liquidity freeze; international banking; liquidity management; derivatives markets;

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  1. Bank for International Settlements, 2007. "Financial stability and local currency bond markets," CGFS Papers, Bank for International Settlements, number 28, January.
  2. Dimitrios P Tsomocos & C.A.E. Goodhart, 2007. "Analysis of Financial Stability," Economics Series Working Papers 2007-FE-04, University of Oxford, Department of Economics.
  3. Robert N McCauley & Patrick McGuire, 2009. "Dollar appreciation in 2008: safe haven, carry trades, dollar shortage and overhedging," BIS Quarterly Review, Bank for International Settlements, December.
  4. José De Gregorio, 2010. "Jos De Gregorio on Howard Davies and David Green: Banking on the Future. The Fall and Rise of Central Banking," World Economics, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 11(4), October.
  5. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
  6. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
  7. Morris Goldstein & Philip Turner, 2004. "Controlling Currency Mismatches in Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 373.
  8. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking and the international policy response," BIS Working Papers 291, Bank for International Settlements.
  9. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking," BIS Quarterly Review, Bank for International Settlements, March.
  10. Naohiko Baba & Robert N McCauley & Srichander Ramaswamy, 2009. "US dollar money market funds and non-US banks," BIS Quarterly Review, Bank for International Settlements, March.
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Cited by:
  1. William A. Allen & Richhild Moessner, 2011. "The international propagation of the financial crisis of 2008 and a comparison with 1931," BIS Working Papers 348, Bank for International Settlements.

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