The ECB and the Interbank Market

Abstract

We analyse the impact on the euro area economy of the ECB's non-standard monetary policy measures by studying the effect of the expansion of intermediation of interbank transactions across the central bank balance sheet. We exploit data drawn from the aggregated Monetary and Financial Institutions (MFI) balance sheet, which allows us to construct a measure of the 'policy shock' represented by the ECB's increasing role as a financial intermediary. We find small but significant effects both on loans and real economic activity. The interbank market is central to the entire financial system: in normal times, it is the main venue for banks to obtain short-term financing. The seizing up of the interbank market therefore threatened financial stability more widely and, through its effect on liquidity and credit availability, also macroeconomic performance.To prevent these malicious effects, the ECB stepped in with a series of measures designed to allow banks to continue to obtain short-term finance even while the money market was dysfunctional.Two crucial elements of the ECB initiatives in 2008 were: First, to adopt a 'fixed rate / full allotment' tender procedure in its operations, which allowed banks to get access to a potentially unlimited amount of financing from central bank operations at a low and predictable borrowing rate, provided that they post sufficient amounts of eligible collateral; and second, to broaden the collateral eligible for those operations, such that the freezing in some market segments would not lead to a shortage of collateral for Eurosystem operations.We characterise these measures as facilitating an expansion of the intermediation of bankto-bank transactions across the ECB balance sheets, which could substitute for the normal transactions in the money market that were no longer taking place.In this paper, we can explore this substitution more directly than in previous work, since we exploit data drawn from the aggregate Monetary and Financial Institutions (MFI) balance sheet. These data allow us to identify both: (a) transactions between banks; and (b) transactions between banks and the ECB. We show that the latter grew following the introduction of non-standard measures, while the former declined. 3 We use this analysis to explore the macroeconomic implications of the ECB's measures.We demonstrate that, by ensuring banks maintained access to short-term financing, the measures avoided a collapse of liquidity and credit. In turn, this helped to sustain economic activity.More specifically, we find that bank loans to households and, in particular, to non-financial corporations are higher than would have been the case without the ECB's intervention.In turn, the ECB's support has a significant impact on economic activity: according to the analysis presented in this paper, two and a half years after the failure of Lehman Brothers, the level of industrial production is estimated to be 2% higher, and the unemployment rate 0.6 percentage points lower, than would have been the case in the ab...

Global banking and the conduct of macroprudential policy in a monetary union

“…This feature gives rise to an interbank market where liquid banks provide interbank loans to both home and foreign banks. This feature is line with the current European banking system characterized by banks relying on wholesale fundings as illustrated by Giannone et al (2012). In our setup, the distinction between liquid and illiquid banks lies in the direct access of liquid banks to ECB fundings which allow intra-financial sector flows between financial intermediaries.…”

Lenders on the storm of wholesale funding shocks: saved by the central bank?

“…13 If we combine this outcome with the finding above that the difference between high and low borrowing banks in lending responses to shocks in MFI is not obvious, we conclude that the availability of central bank funding mitigated the impact of wholesale funding shocks on bank lending. In line with Ciccarelli et al (2013) and Giannone et al (2012), we find that the extended liquidity operations by the ECB neutralized the effect of the bank lending channel.…”

Conditional forecasts and scenario analysis with vector autoregressions for large cross-sections

“…The procedure is computationally feasible, produces meaningful results and interesting insights. The methodology has been already used in a number of papers including Giannone, Lenza, Momferatou, and Onorante (2014), Reichlin (2010, 2012), Giannone, Lenza, Pill, and Reichlin (2012), Lenza, Pill, and Reichlin (2010) and Luciani (2013).…”

“…Notable examples of the latter are the stress tests recently conducted in the US and the euro area in order to assess the vulnerability of their banking systems. For recent examples of conditional forecasts, see Lenza, Pill, and Reichlin (2010); Giannone, Lenza, and Reichlin (2010); Jarociński and Smets (2008); Bloor and Matheson (2011) ;Giannone, Lenza, Pill, and Reichlin (2012); Stock and Watson (2012a); Giannone, Lenza, Momferatou, and Onorante (2014). Recently, Clark and McCracken (2014) propose and evaluate a range of tests of predictive ability for conditional forecasts from estimated models.…”