We empirically investigate the effect that relationship lending has on the availability and pricing of interbank liquidity. Our analysis is based on a daily panel of unsecured overnight loans between 1,079 distinct German bank pairs from March 2006 to November 2007, a period that includes the 2007 liquidity crisis that marked the beginning of the 2007–08 global financial crisis. We find that (i) relationship lenders are more likely to provide liquidity to their closest borrowers, (ii) particularly opaque borrowers obtain liquidity at lower rates when borrowing from their relationship lenders, and (iii) during the crisis, relationship lenders provided cheaper loans to their closest borrowers. Our results hold after controlling for search frictions as well as a large set of (time-varying) bank and bank-pair control variables and fixed effects. While we find some indication that lending relationships help banks reduce search frictions in the over-the-counter interbank market, our results establish that bank-pair relationships have a significant impact on interbank credit availability and pricing due to mitigating uncertainty about counterparty credit quality.

We use a unique data set that comprises for each German bank its recourse to the Eurosystem’s marginal lending facility (MLF) along with a large variety of detailed bank level data including the daily liquidity position to study the drivers of banks’ recourse to the LOLR facility for the period January 2004 to October 2010. We find that larger banks and banks with lower liquidity buffers and higher idiosyncratic liquidity risks make more frequent and extensive use of the LOLR support. These results not only hold for crises periods and episodes of tight money markets but also for tranquil periods, irrespective of the different monetary policy regimes. Our results have two implications: First, they suggest that riskier banks benefit more from the LOLR-facility, which might affect competition in the financial sector, promoting riskier banks and foster risk-taking behaviour. Second, data on banks’ reserve management can be a useful tool for microprudential supervision to derive high-frequency indicators for predicting liquidity shortages at the individual bank level.

During the 6-month period from December 2005 to June 2006, the German Real Estate mutual fund industry suffered an unprecedented liquidity crisis. We investigate to what extend competing theories of liquidity crises help explain this event. Our results show that fundamental factors not only mattered for the liquidity outflow in normal times but also during the crisis. However, strategic complementarities accelerated the withdrawals during the crisis suggesting that pure panic behavior contributed substantially to the massive outflows. Thus higher liquidity buffers might help mitigating these tail events. Furthermore, we find that funds with a lower fraction of shares held by institutional investors suffered from less significant outflows suggesting that a segmentation of funds for different investor groups might help mitigate panics.

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.

We use a unique data set that comprises each Euro area bank’s daily recourse to the ECB’s marginal lending facility (MLF) and all its bids placed in the ECB’s main refinancing operations (MROs) that were conducted as variable rate tenders until October 2008. We show that the more aggressive a bank bids in a MRO, the higher is its propensity to subsequently draw on the MLF. Our results indicate that particularly with the beginning of the financial crisis, the interest rate paid by a bank in a variable rate tender auction strongly reflects its private value for liquidity, i.e. its opportunity costs of obtaining short-term funding in money markets, and thus, the risk premium it is charged in the private market. This suggests 1) that variable rate tender auctions preserve some market discipline and contain moral hazard issues, especially in times when a central bank is extending its liquidity provision and 2) that the average interest rate paid in an auction can be a useful indicator for bank supervisors to gauge a bank’s access to liquidity in money markets.

This paper analyzes the individual bidding behavior of German banks in the money market auctions conducted by the ECB from the beginning of 2000:IIIQ to the end of 2001:IQ. Our approach takes a variety of characteristics of the individual banks into account, particularly 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 banks’ bidding behavior. Thus, our study contributes to a deeper understanding of the way liquidity risk is managed in the banking sector.

We study the prices that individual banks pay for liquidity (captured by borrowing rates in repos with the central bank and benchmarked by the overnight index swap) as a function of market conditions and bank characteristics. These prices depend in particular on the distribution of liquidity across banks, which is calculated over time using individual bank-level data on reserve requirements and actual holdings. Banks pay more for liquidity when positions are more imbalanced across banks, consistent with the existence of short squeezing. We also show that small banks pay more for liquidity and are more vulnerable to squeezes. Healthier banks pay less but, contrary to what one might expect, banks in formal liquidity networks do not. State guarantees reduce the price of liquidity but do not protect against squeezes.

In this study, we examine the trading book of a major dealer in the European unsecured money market, focusing on the impact of a dealer’s own funding liquidity risk on the pricing of his interbank trades pre- and post- the 2007/08 financial crisis. Our analysis reveals two key insights: First, utilizing a panel model, we observe that heightened funding liquidity risks for the dealer generally affect his quoted prices for interbank liquidity. Second, while in tranquil periods this effect is statistically significant but economically less pronounced, the collapse of Lehman Brothers led to a strong liquidity pricing effect: a one standard deviation increase in the funding liquidity risk of the dealer translated to a 11 basis points higher mid-price for overnight liquidity. We thus find evidence that funding liquidity risks exacerbated the overall contraction of money market liquidity during this period.