Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-Prime Crisis

55 Pages Posted: 27 Sep 2010 Last revised: 20 Apr 2023

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Ouarda Merrouche

European University Institute

Multiple version iconThere are 4 versions of this paper

Date Written: September 2010

Abstract

We study the liquidity demand of large settlement banks in the UK and its effect on the Sterling Money Markets before and during the sub-prime crisis of 2007-08. Liquidity holdings of large settlement banks experienced on average a 30% increase in the period immediately following 9th August, 2007, the day when money markets froze, igniting the crisis. Following this structural break, settlement bank liquidity had a precautionary nature in that it rose on calendar days with a large amount of payment activity and more so for weaker banks. We establish that the liquidity demand by settlement banks caused overnight inter-bank rates to rise, an effect virtually absent in the pre-crisis period. This liquidity effect on inter-bank rates occurred in both unsecured borrowing as well as borrowing secured by UK government bonds. Further, the effect was experienced by all settlement banks, regardless of their credit risk, suggestive of an interest-rate contagion from weaker to stronger banks operating through the inter-bank markets.

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Merrouche, Ouarda, Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-Prime Crisis (September 2010). NBER Working Paper No. w16395, Available at SSRN: https://ssrn.com/abstract=1683165

Viral V. Acharya (Contact Author)

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New York University (NYU) - Department of Finance ( email )

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Ouarda Merrouche

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