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

61 Pages Posted: 10 Sep 2013

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

Date Written: December 2011

Abstract

We study the liquidity demand of large settlement banks in the UK and its eect 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 eect virtually absent in the pre-crisis period. This liquidity eect on inter-bank rates occurred in both unsecured borrowing as well as borrowing secured by UK government bonds. Further, the eect 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: Evidencefrom the Sub-Prime Crisis (December 2011). NYU Working Paper No. 2451/31366, Available at SSRN: https://ssrn.com/abstract=2323475

Viral V. Acharya (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

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

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Centre for Economic Policy Research (CEPR) ( email )

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Ouarda Merrouche

World Bank ( email )

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