Frictions in the Interbank Market: Evidence from Volumes

Abstract

Since the financial crisis it is evident that the functioning of the interbank market is vital for the stability of the financial markets. In this paper I look at its regularities in traded volumes due to regulatory requirements and the impact of frictions. The frictions identified (squeezing, credit risk, uncertainty and exposure to asset markets) affect each segment of the interbank market differently. In combination with the empirical regularities those frictions amplify the segmentation of the interbank market, thus inhibiting the efficient redistribution of liquidity within this market. The analysis combines data on the unsecured and secured overnight market with data on the use of the standing facilities at the Eurosystem, which is spearheaded by the European Central Bank. Before Lehman allocational inefficiencies can be detected. During the crisis the interbank market is mainly characterized by the impact of credit risk, which leads to market segmentation. Moreover, there is a link to other asset markets impacting the distribution of liquidity. Higher expected stock market volatility raises the demand for repo transactions in liquid assets. Finally, the results suggest that frictions persist in the course of the crisis despite the extensive measures taken by the Eurosystem.