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The functioning of the European interbank market during the 2007-08 financial crisis

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    Abstract

    This paper analyses the functioning of the overnight unsecured euro money market during the ongoing crisis in terms of i) operational efficiency of monetary policy implementation, ii) efficient reallocation of banking system’s reserves, iii) developments in the pricing of interbank loans. The results suggest that monetary policy implementation has been hampered by the crisis, particularly after the end of September 2008. A heightened awareness of counterparty credit risk seems to be one key factor behind the downward pressure on unsecured rates, as well as behind the notable increase in their cross-section dispersion. Starting from September 2008, and even more in October 2008, banks perceived as relatively “riskier” pre-turmoil paid significantly higher interest rates to borrow overnight funds. In November, a non-uniform softening of the strains occurred: only the most active (roughly the largest) borrowers experienced a notable price improvement. This is possibly a reflection of the bailouts of “too-big-to-fail” institutions. Heterogeneous developments in banks’ funding costs also suggest a move against the integration of the euro interbank market.

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    File URL: ftp://www.ceistorvergata.it/repec/rpaper/RP158.pdf
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    Bibliographic Info

    Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 158.

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    Length: 33 pages
    Date of creation: 28 May 2010
    Date of revision: 28 May 2010
    Handle: RePEc:rtv:ceisrp:158

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    Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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    Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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    Web: http://www.ceistorvergata.it

    Related research

    Keywords: Interbank market; Financial crisis; Monetary policy operational efficiency; Moral hazard; European financial integration;

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    1. Heider, Florian & Hoerova, Marie & Holthausen, Cornelia, 2009. "Liquidity hoarding and interbank market spreads: the role of counterparty risk," Working Paper Series 1126, European Central Bank.
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    12. Benito, Francis & Leon, Angel & Nave, Juan, 2007. "Modeling the Euro overnight rate," Journal of Empirical Finance, Elsevier, vol. 14(5), pages 756-782, December.
    13. Furfine, Craig H, 2001. "Banks as Monitors of Other Banks: Evidence from the Overnight Federal Funds Market," The Journal of Business, University of Chicago Press, vol. 74(1), pages 33-57, January.
    14. Claudio Borio, 2008. "The financial turmoil of 2007-?: a preliminary assessment and some policy considerations," BIS Working Papers 251, Bank for International Settlements.
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