Banks as Monitors of Other Banks: Evidence from the Overnight Federal Funds Market

Abstract

This study provides evidence that banks are effective monitors of their peers by showing that the interest rate paid on federal funds transactions reflects differences in credit risk across borrowers. In addition, the size and relative importance in the funds market of the trading institutions are shown to affect the rates charged for overnight borrowing, thereby providing insight into the nature of competition in the federal funds market. Transaction volume and size-of-transaction effects are uncovered, as is evidence of relationship banking between banks. These results are made possible by unique data identifying individual federal funds transactions.

Relationship Lending in the Interbank Market and the Price of Liquidity

“…Despite these intrinsic problems the method seems to work reasonably well in identifying interbank loans especially for our sample period, compare Furfine (2001) and Heijmans et al (2011) for an in depth assessment. In particular, the plausibility corridor of EONIA +/-50 basis points does not seem to be a binding constraint in our data since only about 180 out of 20999 candidate loans (with a larger corridor of 1 -10%) fall outside this corridor.…”

“…We use a computer algorithm similar to Furfine (1999Furfine ( , 2001) to identify and extract overnight loans from interbank payment data. This data comprises all transaction records from RTGSplus (Real Time Gross Settlement Plus) the German part of the TARGET system (TransEuropean Automated Real-time Gross settlement Express Transfer system), the large value payment system of the Eurosystem.…”

“…16 Furfine (2001) has documented a significant effect of bank's equity ratio on the interest rates it pays in the federal funds market.…”

Evaluating the Quality of Fed Funds Lending Estimates Produced from Fedwire Payments Data

“…Specifications (2) and (4) The algorithm used to identify fed funds loans is similar to the one proposed by Furfine (1999). This technique has been used to identify uncollateralized loans in the U.S. settled over the Fedwire Funds Service in Furfine (2001Furfine ( , 2002, Demiralp, Preslopsky, and Whitesell (2004), Ashcraft and Bleakley (2006), Ashcraft and Duffie (2007), Bech and Atalay (2008), and Bartolini, Hilton, and McAndrews (2010), among others. Modified versions of this methodology are also employed by and Acharya and Merrouche (2010) to identify overnight lending activity in the U.K. CHAPS Sterling and by Hendry and Kamhi (2007) in Canada's Large Value Transfer System (LVTS).…”

How Amsterdam got fiat money

“…The Federal Reserve System, for example, publishes its balance sheet on a weekly basis (the H.4.1 release) and publishes daily data on the market price of its liabilities (the effective fed funds rate). Some studies have even examined records of individual transactions over central banks' payment systems (for Fedwire, see e.g., Bartolini et al 2008;Furfine 1999Furfine , 2001Furfine , 2003Furfine , 2006McAndrews and Potter 2002;McAndrews and Rajan 2000) to analyze money market activity. Almost incredibly, much of this same information is preserved for the Bank of…”