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Repo Market – A Tool to Manage Liquidity in Financial Institutions

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  • Nath, Golaka
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    Abstract

    Repo is used in India as an instrument for monetary policy by institutionalizing daily Liquidity Adjustment Facility (LAF) which allows banks and Primary Dealers to manage their liquidity needs. Liquidity stress in the market has an impact on the short term interest rate. Entities not having adequate securities balances borrow funds from inter-bank uncollateralized call market and the call rates are prone to liquidity shocks in the system. The spread between Call and Repo rates is likely to widen when there is liquidity stress in the market. The study tried to find the determinant of the spread. It found that LAF window activity as well as total money market activity has an impact on the spread. In order to understand if the spread behaves in a different manner when the system has excess liquidity vis-à-vis shortage of liquidity, a Regime Switching model using Goldfeld and Quandt’s D-method for switching regression was used. The tests found that the monetary policy is stable in both the regimes and the effectiveness of monetary policy in both the regimes are not statistically different.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 51590.

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    Date of creation: 19 Nov 2013
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    Handle: RePEc:pra:mprapa:51590

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    Related research

    Keywords: Repo; CBLO; Call; India; RBI; liquidity; financial crisis; central bank refinancing; spread; interbank market;

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    1. Viral V. Acharya & David Skeie, 2011. "A model of liquidity hoarding and term premia in inter-bank markets," Staff Reports, Federal Reserve Bank of New York 498, Federal Reserve Bank of New York.
    2. Jean-Charles Rochet & Xavier Vives, 2002. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," FMG Discussion Papers, Financial Markets Group dp408, Financial Markets Group.
    3. Viral V. Acharya & Ouarda Merrouche, 2013. "Precautionary Hoarding of Liquidity and Interbank Markets: Evidence from the Subprime Crisis," Review of Finance, European Finance Association, European Finance Association, vol. 17(1), pages 107-160.
    4. Viral V. Acharya & Douglas Gale & Tanju Yorulmazer, 2010. "Rollover Risk and Market Freezes," NBER Working Papers 15674, National Bureau of Economic Research, Inc.
    5. Flannery, Mark J, 1996. "Financial Crises, Payment System Problems, and Discount Window Lending," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 28(4), pages 804-24, November.
    6. Affinito, Massimiliano, 2012. "Do interbank customer relationships exist? And how did they function in the crisis? Learning from Italy," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(12), pages 3163-3184.
    7. Stephen Godfeld & Richard Quandt, 1973. "The Estimation Of Structural Shifts By Switching Regressions," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 2, number 4, pages 473-483 National Bureau of Economic Research, Inc.
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