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Overnight Interbank Rate Volatility Across Liquidity States: Key Drivers and Policy Implications

Author

Listed:
  • Elmir Mukhtarov

    (Central Bank of Azerbaijan Republic)

  • Ali Hajili

    (Central Bank of Azerbaijan Republic)

  • Aygun Garayeva

    (Central Bank of Azerbaijan Republic)

  • Vugar Ahmadov

    (Central Bank of Azerbaijan Republic)

Abstract

Effective monetary policy requires maintaining the short-term interbank rate close to the policy rate while limiting its volatility, ensuring smooth transmission, and reducing banks’ liquidity and interest rate risks. This paper seeks to identify and explain the drivers of volatility in short-term interbank rates, while examining the impact of the reserve averaging framework on banking sector liquidity. Drawing on evidence from an emerging market, this study demonstrates that deviations of cumulative reserves from their trend exert a significant influence on interbank rate volatility. Specifically, the results identify distinct states in the money market: a high-responsiveness state and a low-responsiveness state, depending on prevailing liquidity conditions. The findings imply that central banks should closely monitor cumulative reserve positions and proactively guide liquidity toward its trend path.

Suggested Citation

  • Elmir Mukhtarov & Ali Hajili & Aygun Garayeva & Vugar Ahmadov, 2025. "Overnight Interbank Rate Volatility Across Liquidity States: Key Drivers and Policy Implications," Working Papers 2502, Central Bank of Azerbaijan Republic.
    • Handle: RePEc:aze:wpaper:2502
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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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