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

78 Pages Posted: 15 Dec 2011 Last revised: 30 Apr 2012

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

World Bank

Multiple version iconThere are 4 versions of this paper

Date Written: April 27, 2012

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 for banks with greater credit risk. 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 more strongly linked to lender risk than to borrower risk.

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 (April 27, 2012). NYU Working Paper No. FIN-11-033, Available at SSRN: https://ssrn.com/abstract=1972804

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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