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

  • Domanski, Dietrich

    (Asian Development Bank Institute)

  • Turner, Philip

    (Asian Development Bank Institute)

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://www.adbi.org/files/2011.06.24.wp291.great.liquidity.freeze.intl.banking.pdf
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Paper provided by Asian Development Bank Institute in its series ADBI Working Papers with number 291.

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Length: 35 pages
Date of creation: 24 Jun 2011
Date of revision:
Handle: RePEc:ris:adbiwp:0291
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  1. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market liquidity and funding liquidity," LSE Research Online Documents on Economics 24478, London School of Economics and Political Science, LSE Library.
  2. 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.
  3. Morris Goldstein & Philip Turner, 2004. "Controlling Currency Mismatches in Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 373, March.
  4. Charles Goodhart & Dimitrios Tsomocos, 2007. "Analysis of Financial Stability," FMG Special Papers sp173, Financial Markets Group.
  5. Bank for International Settlements, 2007. "Financial stability and local currency bond markets," CGFS Papers, Bank for International Settlements, number 28, April.
  6. 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.
  7. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
  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. 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.
  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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