Template-Type: ReDIF-Paper 1.0
Author-Name: Angelo Baglioni
Author-X-Name-First: Angelo 
Author-X-Name-Last: Baglioni
Author-Email: angelo.baglioni@unicatt.it
Author-Workplace-Name: DISCE, Università Cattolica
Title: Liquidity crunch in the interbank market: is it credit or liquidity risk, or both?
Abstract: The interplay between liquidity and credit risks in the interbank
market is analyzed. Banks are hit by idiosyncratic random liquidity
shocks. The market may also be hit by a bad news at a future date, implying
the insolvency of some participants and creating a lemon problem;
this may end up with a gridlock of the interbank market at that date. Anticipating
such possible contingency, banks currently long of liquidity ask a
liquidity premium for lending beyond a short maturity, as a compensation
for the risk of being short of liquidity later and being forced to liquidate some
illiquid assets. Then banks currently short of liquidity may prefer to borrow
short term. The model is able to explain some stylized facts of the 2007-
2009 liquidity crunch affecting the money market at the international level:
(i) high spreads between interest rates at different maturities; (ii) "flight to
overnight" in traded volumes; (iii) ineffectiveness of open market operations,
leading the central banks to introduce some relevant innovations into their operational framework.
Length: 30
Creation-Date: 2009-11
File-URL: http://www.unicatt.it/Istituti/EconomiaFinanza/Quaderni/ief0091.pdf
File-Format: Application/pdf
File-Function: First version, 2009
Number: ief0091
Classification-JEL: G01, G21, E43, E50
Keywords: Global financial crisis, Money market, Liquidity, Central banking.
Handle: RePEc:ctc:serie3:ief0091