Search

Most central banks offer banks participating in large‐value real‐time gross settlement (RTGS) systems a free intraday overdraft facility to discourage banks from actively managing their daylight liquidity. In this paper, we ask whether this facility has kept the intraday interest rate at zero. Using a unique transaction‐level data set on collateralized interbank loans for 2006–12, we find that during periods of financial distress, rates for morning transactions are higher than those in the afternoon. Moreover, this intraday rate correlates with market liquidity, suggesting that rates contain a liquidity premium. This intraday pattern is reduced, but not eliminated by the Eurosystem's accommodative liquidity provision.

This article shows how the recent money market disruptions with elevated counterparty risks and uncertainty about the fundamental value of liquidity influenced the trading behaviour of a key dealer in the Euro money market. The complete trading record in the unsecured segment of the money market for 2007 and 2008 is used to estimate a stylized pricing model, which explicitly accounts for the over-the-counter structure. The empirical results suggest that the market maker learns from order flow, but this information aggregation was increasingly hampered as the crisis unfolded.

In a framework closely related to Diamond and Rajan (J Polit Econ 109:287–327, 2011) we characterize different financial systems and analyze the welfare implications of different central bank policies in these financial systems. We show that in case of a large negative liquidity shock, liquidity demand has lower interest rate elasticity in a bank-based financial system than in a market oriented financial system. Market interventions, i.e. non-standard monetary policy measures to inject liquidity need to be much larger in a bank-based financial system in order to bring down interest rates to sustainable levels. Therefore, in financial systems with rather illiquid assets an individual liquidity assistance might be welfare improving, while in market oriented financial systems, with rather liquid assets in the banks’ balance sheets, liquidity assistance provided freely to the market at a penalty rate is likely to be efficient. While the costs of individual support might not be worthwhile in a market oriented financial system in which deadweight losses of market based support are small, in a bank based system the deadweight losses of unconventional monetary policy are large and thus individual support more efficient.

This paper studies the implications of cross-border financial integration for financial stability when banks' loan portfolios adjust endogenously. Banks can be subject to sectoral and aggregate domestic shocks. After integration they can share these risks in a complete interbank market. When banks have a comparative advantage in providing credit to certain industries, financial integration may induce banks to specialize in lending. An enhanced concentration in lending does not necessarily increase risk, because a well-functioning interbank market allows to achieve the necessary diversification. This greater need for risk sharing, though, increases the risk of cross-border contagion and the likelihood of widespread banking crises. However, even though integration increases the risk of contagion it improves welfare if it permits banks to realize specialization benefits.

Financial innovation and greater information availability have increased the tradability of bank assets and have reduced banks’ dependence on individual bank managers. We show that this can have two opposing consequences for banking stability. First, the hold-up problem between bank managers and shareholders becomes less severe. Consequently, banks’ capital structure needs to be less concerned with disciplining the management. Deposits – the most effective disciplining device – can be reduced, increasing banks’ resilience to adverse return shocks. However, limiting the hold-up problem also diminishes bank managers’ rents, reducing their incentives to properly monitor and screen borrowers, with adverse implications for asset quality. Thus, the default risk of banks does not necessarily decline. We argue that this delivers a novel explanation for the origin of the recent subprime crisis.

Heterogenous banking supervision and regulation is often considered as the most important impediment for Pan-European Bank mergers. In this paper we identify other more fundamental reasons for a limited degree of cross-country integration in retail banking. We argue that the distribution of regional liquidity shocks may pose a natural limit to the extent of cross-border bank mergers. The paper derives the impact of different underlying stochastic structures on the optimal structure of cross regional bank mergers. Imposing a symmetry restriction on the underlying stochastic structure of liquidity shocks we find that benefits from diversification and the costs of contagion may be optimally traded off if banks from some but not from all regions merge. Under an additional monotonicity assumption full integration is only desirable if the number of regions with diverse risks is sufficiently large.

In this paper, we focus on the interconnectedness of banks and the price they pay for liquidity. We assess how the concentration of credit relationships and the position of a bank in the network topology of the system influence the bank’s ability to meet liquidity demand. We use quarterly data of bilateral interbank credit exposure among all German banks from 2000 to 2008 to measure interbank relationships and network characteristics. We match these data with bids placed by individual banks in the European Central Bank’s (ECB) weekly repo auctions. The bids measure each bank’s willingness to pay for liquidity, since they had variable rate tenders with a “pay-your-bid” price. Controlling for bank characteristics and the daily fulfillment of reserve requirements, we find that banks with a more diversified borrowing structure in the interbank market bid significantly less aggressively and pay a lower price for liquidity in the ECB’s main refinancing operations. These findings suggest that incentives to diversify banks’ liquidity risk dominate the benefits of private information. When the network position of the bank is taken into account, we find that central lenders in the money market bid more aggressively in auctions.

This paper empirically investigates the effect of interbank relationship lending on banks' access to liquidity. Our analysis is based on German interbank payment data which we use to create a panel of unsecured overnight loans between 1079 distinct borrower-lender pairs. The data shows that banks rely on repeated interactions with the same counterparties to trade liquidity. For the price of liquidity, we find that in the run-up to the recent financial crisis of 2007/08 relationship lenders charged already higher interest rates to their borrowers after controlling for other bank specific characteristics and general market conditions. By contrast, during the crisis borrowers paid on average lower rates to their relationship lenders compared to spot lenders. The observed interest rate differences are statistically and economically significant and in line with theory that relationship lenders have private information about the creditworthiness of their close borrowers.

This paper studies the implications of cross-border financial integration for financial stability when banks' loan portfolios adjust endogenously. Banks can be subject to sectoral and aggregate domestic shocks. After integration they can share these risks in a complete interbank market. When banks have a comparative advantage in providing credit to certain industries, financial integration may induce banks to specialize in lending. An enhanced concentration in lending does not necessarily increase risk, because a well-functioning interbank market allows to achieve the necessary diversification. This greater need for risk sharing, though, increases the risk of cross-border contagion and the likelihood of widespread banking crises. However, even though integration increases the risk of contagion it improves welfare if it permits banks to realize specialization benefits.

Summary Open-End Real Estate Funds in Germany – Genesis and Crisis Open-end real estate funds are of particular importance in the German bank-dominated financial system. However, recently the German open-end fund industry came under severe distress which triggered a broad discussion of required regulatory interventions. This paper gives a detailed description of the institutional structure of these funds and of the events that led to the crisis. Furthermore, it applies recent banking theory to open-end real estate funds in order to understand why the open-end fund structure was so prevalent in Germany. Based on these theoretical insights we evaluate the various policy recommendation that have been raised. (JEL G14, G21, G23)

In this paper, we address the question whether increasing households' financial market access improves welfare in a financial system in which there is intense competition among banks for private households' funds. Following earlier work by Diamond and by Fecht, we use a model in which the degree of liquidity insurance offered to households through banks' deposit contracts is restrained by households' financial market access. However, we also assume spatial monopolistic competition among banks. Because monopoly rents are assumed to bring about inefficiencies, improved financial market access that limits monopoly rents also entails a positive effect; however, this beneficial effect is only relevant if competition among banks does not sufficiently restrain monopoly rents already. ; Thus, our results suggest that in Germany's bank-dominated financial system, which is characterized by intense competition for households' deposits, improved financial market access might reduce welfare because it only reduces risk sharing. In contrast, in the U.S. banking system, where there is less competition for households' deposits, a high level of household financial market participation might be beneficial.

This paper analyzes the individual bidding behavior of German banks in the money market auctions conducted by the ECB from the beginning of the third quarter of 2000 to the end of the first quarter of 2001. Our approach takes a variety of characteristics of the individual banks into account. In particular, we consider variables that capture the different use of liquidity and the different attitude towards liquidity risk of the individual banks. It turns out that these characteristics are reflected in the banks’ respective bidding behavior to a large extent. Thus our study contributes to a deeper understanding of the way liquidity risk is managed in the banking sector.

Following Diamond (1997) we use a model in which financial market access of households restrains the efficiency of the liquidity insurance that banks' deposit contracts provide to households that are subject to idiosyncratic liquidity shocks. But in contrast to these approaches we assume spatial monopolistic competition among banks. Since monopoly rents are assumed to bring about inefficiencies, improved financial market access that limits monopoly rents also entails a positive effect. But this beneficial effect is only relevant if competition among banks does not sufficiently restrain monopoly rents already. Thus, our results suggest that in the bank-dominated financial system of Germany, in which banks intensely compete for households' deposits, improved financial market access might reduce welfare because it only reduces risk sharing. In contrast, in the banking system of the U.S., with less competition for households' deposits, a high level of households' financial market participation might be beneficial.

In many models of financial intermediation, markets reduce welfare because they limit the amount of risk-sharing intermediaries can offer. In this paper we study a model in which markets also promote investment in a productive technology. A trade-off between risk sharing and growth arises endogenously. In the model, financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. We show the mix of intermediaries and market that maximizes welfare depend on parameter values. We also show the optimal mix of two very similar economies can be very different.

In many models of financial intermediation, markets reduce welfare because they limit the amount of risk-sharing intermediaries can offer. In this paper we study a model in which markets also promote investment in a productive technology. A trade-off between risk sharing and growth arises endogenously. In the model, financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. We show the mix of intermediaries and market that maximizes welfare depends on parameter values. We also show the optimal mix of two very similar economies can be very different.

An economy in which deposit-taking banks of a Diamond/Dybvig style and an asset market coexist is modelled. Firstly, within this framework we characterize distinct financial systems depending on the fraction of households with direct investment opportunities that are less efficient than those available to banks. With this fraction comparatively low, the evolving financial system can be interpreted as market-oriented. In this system, banks only provide efficient investment opportunities to households with inferior investment alternatives. Banks are not active in the secondary financial market nor do they provide any liquidity insurance to their depositors. Households participate to a large extent in the primary as well as in the secondary financial markets. In the other case of a relatively high fraction of households with inefficient direct investment opportunities, a bank-dominated financial system arises, in which banks provide liquidity transformation, are active in secondary financial markets and are the only player in primary markets, while households only participate in secondary financial markets. Secondly, we analyze the effect a run on a single bank has on the entire financial system. Interestingly, we can show that a bank run on a single bank causes contagion via the financial market neither in market- oriented nor in extremely bank-dominated financial systems. But in only moderately bank-dominated (or hybrid) financial systems fire sales of long-term financial claims by a distressed bank cause a sudden drop in asset prices that precipitates other banks into crisis.