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Precautionary reserves and the interbank market

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Author Info
Adam Ashcraft
James McAndrews
David Skeie

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Abstract

Liquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using data on intraday account balances held by banks at the Federal Reserve and Fedwire interbank transactions to estimate all overnight fed funds trades, we present empirical evidence on banks' precautionary hoarding of reserves, their reluctance to lend, and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Our theoretical results show that banks rationally hold excess reserves intraday and overnight as a precautionary measure against liquidity shocks. Moreover, the intraday fed funds rate can spike above the discount rate and crash to near zero. Apparent anomalies during the financial crisis may be seen as stark but natural outcomes of our model of the interbank market. The model also provides a unified explanation for several stylized facts and makes new predictions for the interbank market.

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Publisher Info
Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 370.

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Date of creation: 2009
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Handle: RePEc:fip:fednsr:370

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Related research
Keywords: Bank reserves ; Federal funds rate ; Interbank market ; Liquidity (Economics);

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Adam B. Ashcraft & Darrell Duffie, 2007. "Systemic Illiquidity in the Federal Funds Market," American Economic Review, American Economic Association, vol. 97(2), pages 221-225, May. [Downloadable!]
  2. Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October. [Downloadable!] (restricted)
  3. Allen, Linda & Peristiani, Stavros & Saunders, Anthony, 1989. "Bank Size, Collateral, and Net Purchase Behavior in the Federal Funds Market: Empirical Evidence," Journal of Business, University of Chicago Press, vol. 62(4), pages 501-15, October. [Downloadable!] (restricted)
  4. Allen, Linda & Saunders, Anthony, 1986. "The large-small bank dichotomy in the federal funds market," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 219-230, June. [Downloadable!] (restricted)
  5. Quiros, Gabriel Perez & Mendizabal, Hugo Rodriguez, 2006. "The Daily Market for Funds in Europe: What Has Changed with the EMU?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 91-118, February. [Downloadable!] (restricted)
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  1. Philip Strahan, 2008. "Liquidity Production in 21st Century Banking," NBER Working Papers 13798, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 235-263. [Downloadable!]
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This page was last updated on 2009-11-18.

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