Market microstructure, banks’ behaviour and interbank spreads: evidence after the crisis

Abstract

We present a study of the European electronic interbank market of overnight lending (e-MID) before and after the beginning of the financial crisis. The main goal of the paper is to explain the structural changes of lending/borrowing features due to the liquidity turmoil. Unlike previous contributions that focused on banks' dependent and macro information as explanatory variables, we address the role of banks' behaviour and market microstructure as determinants of the credit spreads. We show that all banks experienced significant variations in their liquidity costs due to the sensitivity of interbank rates to the timing and side of trades. We argue that, while larger banks did experience better funding conditions after the crisis, this was not just a consequence of the "too big to fail" perception of the market. Larger banks have been able to play more strategically when managing their liquidity by taking advantage of the changing market microstructure.Interbank markets play a key role in the liquidity management of banks and in the transmission of monetary policy. Well-functioning interbank markets effectively channel liquidity from financial intermediaries with a surplus of funds to those in need, allowing for more efficient financial intermediation. Variations in interbank rates are transmitted to the entire term structure, affecting borrowing conditions for households and firms. Interbank rates provide benchmarks (e.g. the Libor, Euribor and Eonia) for the pricing of fixed-income securities and derivative contracts such as shortterm interest rate futures and interest rate swaps, used by banks to hedge their short-term interest rate risks. Thus, policymakers have an interest in a financial system with an efficient interbank market, that is, one in which the central bank can achieve its desired rate of interest and one that allows institutions to trade liquidity minimizing transaction costs and information asymmetries.Before the crisis, interbank markets were among the most liquid in the financial sector and the literature has historically devoted a relatively low consideration to the interbank market due to the short-term nature of the exchanged deposits. Banks used to accept non-collateralised loans because counterparties were considered safe and sound enough and liquidity risk was perceived as marginal due to the central bank role as lender of last resort. However, during the 2007-2008 financial crisis, liquidity in the interbank market has considerably dried up, even at short maturities. Also an increasing dispersion in the credit conditions of different banks has emerged. These events have triggered a new interest in interbank markets. The dramatic change of volumes and the drop in the number of active banks after the subprime crisis can be hardly explained as a real reduction of liquidity need by banks.

Multiple clocks in network evolution

“…Splitting the period of observation into four sub-periods mapping onto distinct exchange regimes is consistent with the financial crisis timeline proposed by the European Central Bank (Drudi et al, 2012) and a collection of empirical papers that have recently appeared on peer reviewed journals (Brunetti et al, 2019;Hatzopoulos et al, 2015;Kapar et al, 2020;Temizsoy et al, 2015).…”

Taming financial systemic risk: models, instruments and early warning indicators

“…The problem of markets' illiquidity in generating systemic risk via credit crunch phenomena is also the key topic of the last selected paper by Kapar et al (2019). This paper performs an empirical analysis of the European electronic interbank market (e-MID interbank market) in the period 2006-2009.…”