Abstract
Using a large dataset of all U.S. banks over 2003-2012, we study banks’ liquidity creation and funding ability during the interbank lending crunch. We find, when the interbank market was reluctant to offer liquidity coinsurance, banks with net interbank borrowing positions sought self‐insurance by hoarding liquidity and rationed lending, while net lending banks also hoarded liquidity due to heightened counterparty risk. Net borrowing banks raised rates to draw external funding. Our findings suggest that a well‐functioning interbank market is vital in ensuring the effectiveness of monetary policy during a crisis, and to this end, we propose interbank lending subsidization.
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