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An early warning indicator system to monitor the unsecured interbank funds market

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  • Sarmiento, Miguel
  • Cely, Jorge
  • León, Carlos

Abstract

A core goal of regulators and financial authorities is to understand how market prices convey information on the financial health of its participants. From this viewpoint we build an Early-Warning Indicators System (EWIS) that allows for identifying those financial institutions perceived as risky counterparts by the participants of the interbank market. We use micro-level data from bilateral overnight unsecured loans performed in the interbank market between January 2011 and December 2014. The EWIS identifies those participants that systematically pay high prices for liquidity in this market. We employ coverage tests to estimate EWIS’ robustness and consistency. We find that financial institutions with an elevated frequency of signals tend to exhibit a net borrower liquidity position in the interbank market, hence suggesting they are facing recurrent liquidity needs. Those institutions also exhibit higher probability of insolvency measured by the Z-score indicator. Thus, our results support the existence of market discipline based on peer-monitoring. Overall, the EWIS may assist financial authorities in focusing their attention and resources on those financial institutions perceived by the market as those closer to distress.

Suggested Citation

  • Sarmiento, Miguel & Cely, Jorge & León, Carlos, 2017. "An early warning indicator system to monitor the unsecured interbank funds market," Research in International Business and Finance, Elsevier, vol. 40(C), pages 114-128.
  • Handle: RePEc:eee:riibaf:v:40:y:2017:i:c:p:114-128
    DOI: 10.1016/j.ribaf.2016.12.007
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    3. Miguel Sarmiento, 2019. "The Impact of Exogenous Liquidity Shocks on Banks Funding Costs: Microevidence from the Unsecured Interbank Market," IHEID Working Papers 01-2019, Economics Section, The Graduate Institute of International Studies.

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    More about this item

    Keywords

    Early warning indicators; Interbank markets; Market discipline; Bank risk;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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