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The Great Liquidity Freeze : What Does It Mean for International Banking?

  • Dietrich Domanski

    (Asian Development Bank Institute (ADBI))

  • Philip Turner

In mid-September 2008, following the bankruptcy of Lehman Brothers, international interbank markets froze and interbank lending beyond very short maturities virtually evaporated. Despite massive central bank support operations and purchases of key assets, many financial markets remained impaired for a long time. Why was this funding crisis so much worse than other past major bank failures and why has it proved so hard to cure? This paper suggests that much of that answer lies in the balance sheets of international banks and their customers. It outlines the basic building blocks of liquidity management for a bank that operates in many currencies and then discusses how the massive development of foreign exchange (forex) and interest rate derivatives markets transformed banks’ strategies in this area. It explains how the pervasive interconnectedness between major banks and markets magnified contagion effects. Finally, the paper provides some recommendations for how strategic borrowing choices by international banks could make them more stable and how regulators could assist in this process.

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File URL: http://saber.eaber.org/node/23245
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Paper provided by East Asian Bureau of Economic Research in its series Finance Working Papers with number 23245.

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Date of creation: Jun 2011
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Handle: RePEc:eab:financ:23245
Contact details of provider: Postal: JG Crawford Building #13, Asia Pacific School of Economics and Government, Australian National University, ACT 0200
Web page: http://www.eaber.org

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  1. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
  2. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking and the international policy response," BIS Working Papers 291, Bank for International Settlements.
  3. Dimitrios P Tsomocos & C.A.E. Goodhart, 2007. "Analysis of Financial Stability," Economics Series Working Papers 2007-FE-04, University of Oxford, Department of Economics.
  4. Naohiko Baba & Robert N McCauley & Srichander Ramaswamy, 2009. "US dollar money market funds and non-US banks," BIS Quarterly Review, Bank for International Settlements, March.
  5. Robert N McCauley & Patrick McGuire, 2009. "Dollar appreciation in 2008: safe haven, carry trades, dollar shortage and overhedging," BIS Quarterly Review, Bank for International Settlements, December.
  6. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
  7. Morris Goldstein & Philip Turner, 2004. "Controlling Currency Mismatches in Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 373, December.
  8. José De Gregorio, 2010. "Jos De Gregorio on Howard Davies and David Green: Banking on the Future. The Fall and Rise of Central Banking," World Economics, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 11(4), October.
  9. Bank for International Settlements, 2007. "Financial stability and local currency bond markets," CGFS Papers, Bank for International Settlements, number 28, April.
  10. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking," BIS Quarterly Review, Bank for International Settlements, March.
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