Interbank Lending Research Articles

The Formation of a Core Periphery Structure in Heterogeneous Financial Networks

Recent empirical evidence suggests that financial networks exhibit a core-periphery network structure. This paper aims at giving an explanation for the emergence of such a structure using network formation theory. We propose a simple model of the overnight interbank lending market, in which banks compete for intermediation benefits. Focusing on the role of bank heterogeneity, we find that a core-periphery network cannot be unilaterally stable when banks are homogeneous. A core-periphery network structure can form endogenously, however, if we allow for heterogeneity among banks in size. Moreover, size heterogeneity may arise endogenously if payoffs feed back into bank size.

A Dynamic Network Model of Interbank Lending—Systemic Risk and Liquidity Provisioning

We develop a dynamic model of interbank borrowing and lending activities in which banks are organized into clusters, and adjust their monetary reserve levels to meet prescribed capital requirements. Each bank has its own initial monetary reserve level and faces idiosyncratic risks characterized by an independent Brownian motion, whereas system wide, the banks form a hierarchical structure of clusters. We model the interbank transactional dynamics through a set of interacting measure-valued processes. Each individual process describes the intracluster borrowing/lending activities, and the interactions among the processes capture the intercluster financial transactions. We establish the weak limit of the interacting measure-valued processes as the number of banks in the system grows large. We then use the weak limit to develop asymptotic approximations of two proposed macromeasures (the liquidity stress index and the concentration index), both capturing the dynamics of systemic risk. We use numerical examples to illustrate the applications of the asymptotics and conduct-related sensitivity analysis with respect to various indicators of financial activity.

Systemic credit freezes in financial lending networks

This paper develops a network model of interbank lending, in which banks decide to extend credit to their potential borrowers. Borrowers are subject to shocks that may force them to default on their loans. In contrast to much of the previous literature on financial networks, we focus on how anticipation of future defaults may result in ex ante “credit freezes,” whereby banks refuse to extend credit to one another. We first characterize the terms of the interbank contracts and the patterns of interbank lending that emerge in equilibrium. We then study how shifts in the distribution of shocks can result in complex credit freezes that travel throughout the network. We use this framework to analyze the effects of various policy interventions on systemic credit freezes.

A lending scheme for a system of interconnected banks with probabilistic constraints of failure

We derive a closed form solution for an optimal control problem related to an interbank lending schemes subject to terminal probability constraints on the failure of banks which are interconnected through a financial network. The derived solution applies to a real banks network by obtaining a general solution when the aforementioned probability constraints are assumed for all the banks. We also present a direct method to compute the systemic relevance parameter for each bank within the network.

The (un)intended effects of government bailouts: The impact of TARP on the interbank market and bank risk-taking

We analyze how the inflow of TARP funds in the wake of the 2007/2008 financial crisis impacted banks’ interbank market activity. We show that TARP banks’ interbank market activity was impacted in a statistically and economically significant way. Their interbank lending via federal funds sold increased by 77 percent relative to the mean of the control group of non-TARP banks. We further show that among the TARP banks, the most affected ones also increased credit risk taking, while at the same time not increasing profitability. These findings suggest a new, heretofore not investigated channel through which TARP may have increased banks’ moral hazard incentives.

Cross-border spillovers of macroprudential policy in the Euro area

Financial flows between heterogeneous member states were crucial drivers of the imbalances that culminated in the Euro crisis. Macroprudential instruments, by affecting the behavior of international banks, can have secondary effects on the financial cycles of other member states. However, countercyclical tools like the Basel III capital buffer are mostly set by independent authorities with national stabilization mandates. Should regulators coordinate macroprudential policy, and if so how? Using a small two-country NK model with financial frictions, we show that macroprudential responses in core economies can have destabilizing spillover effects on a financially dependent periphery through interbank lending. We subsequently evaluate a policy rule in which the core regulator internalizes these spillovers and compare it to prevailing national stabilization rule. While national rules deliver a good performance in general, under certain conditions internalization becomes preferable.

Pareto Optima for a Class of Singular Control Games

We analyze a class of stochastic differential games of singular control, motivated by the study of a dynamic model of interbank lending with benchmark rates. We describe Pareto optima for this game and show how they may be achieved through the intervention of a regulator, whose policy is a solution to a singular stochastic control problem. Pareto optima are characterized in terms of the solutions to a new class of Skorokhod problems with piecewise-continuous free boundary. Pareto optimal policies are shown to correspond to the enforcement of endogenous bounds on interbank lending rates. Analytical comparison between Pareto optima and Nash equilibria provides insight into the impact of regulatory intervention on the stability of interbank rates.

The Term Structure of Cip Violations

We show theoretically that persistent deviations from covered interest parity (CIP) across multiple horizons imply simultaneous arbitrage opportunities only if uncollateralized interbank lending rates are riskless. In the absence of observable riskless discount rates, we extract them empirically from interest rate swaps using a simple no-arbitrage framework. They deliver novel quantitative benchmarks that reconcile a zero cross-currency basis with non-zero cross-currency basis swap rates. We quantify that the no-arbitrage benchmark, which is consistent with intermediary-based asset pricing paradigms, accounts for about two thirds of the alleged CIP deviations. The residual pricing errors are associated with the limits-to-arbitrage framework.

Systemic Credit Freezes in Financial Lending Networks

This paper develops a network model of interbank lending, in which banks decide to extend credit to their potential borrowers. Borrowers are subject to shocks that may force them to default on their loans. In contrast to much of the previous literature on financial networks, we focus on how anticipation of future defaults may result in ex ante “credit freezes,” whereby banks refuse to extend credit to one another. We first characterize the terms of the interbank contracts and the patterns of interbank lending that emerge in equilibrium. We then study how shifts in the distribution of shocks can result in complex credit freezes that travel throughout the network. We use this framework to analyze the effects of various policy interventions on systemic credit freezes. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

GLOBAL LIQUIDITY AS AN INSTITUTIONAL PHENOMENON

The content of present day contradictory processes in the world economy plays an important role in choosing the strategy of social and economic development of Ukraine. The article is devoted to the estimation of the «reverse» tendencies of the global financial and institutional environment on the basis of substantiation of the actual and historical significance of global liquidity, and determination on this basis of the content of modern global financial and institutional transformationsLiquidity is treated as the amount of available financing for the acquisition of both internal and cross-border assets; it describes the ability and willingness of the parties to take part in financial transactions, including mediation, and the ability of the financial markets to absorb temporary fluctuations in demand and supply of certain assets.The globality of liquidity is manifested through the interconnection of the national financial space and the cross-border movement of financial capital. The mechanisms for transmitting information on the internal conditions of the development of countries to the world financial markets and operators, which influences the rapid movement of financial flows in space and time, plays an important role. The modern development of financial technologies has given rise to such recent phenomena as liquidity and information surplus. As a result, the public need in financial intermediation institutions is gradually disappearing or regenerating.Global liquidity has national institutional sources of origin and reflects the interests of specific issuers and investors. This causes difficulty in institutional provision of international coordination on its regulatation. When circulating in the global financial and institutional space, liquidity has significant influence on supply and demand fluctuations not only in the financial markets, but in the economy as a whole. The current tendency towards decreasing the volume of the world interbank lending is not the sign of globalization, but the sign of change in the vectors of the development of globalization towards other financial mechanisms. The active introduction of new financial instruments (cryptocurrencies) into the world’s payment cycle and the policies of the leading regulators in the financial markets show that financial globalization is going on.

EXCHANGE RATE CHANNEL OF TRANSMISSION MECHANISM OF THE NBU’S MONETARY POLICY

The essence of exchange rate channel of transmission mechanism of the monetary policy is considered. Pearson’s, Spearman’s, and Kendall’s correlation coefficients were applied to calculate the relationship between variables. It is emphasized that the exchange rate channel of the monetary policy transmission mechanism reflects its impact on output and price level due to changes in the exchange rate of the national currency. It is noted that the hryvnia devaluation has always been observed against the background of economic crises and declining exports. In all three cases of sharp devaluation, the crises were accompanied by a significant drop in exports of goods, which reduced the NBU's reserve assets. In general, the NBU conducted interventions to counteract excessive fluctuations in the national currency exchange rate, selling currency during periods of devaluation and buying it during periods of revaluation. In addition, there is an inverse relationship between the discount rate and the official hryvnia exchange rate from January 2015 to October 2019. In other words, the higher the discount rate, the lower the USD price expressed in UAH is. In addition, the Pearson’s correlation coefficients indicate a strengthening of the relationship between the official hryvnia exchange rate against the U.S dollar and the lagged discount rate. In other words, raising the interest rate in the current month will have a long-term impact on the value of the dollar, expressed in UAH. The strongest link between the discount rate and the official hryvnia exchange rate is in the first leg, with the link loosening in the next. The values of the Kendall correlation coefficients show the same as the previous coefficients. First, the relationship between the official hryvnia exchange rate against the U.S dollar and lag values of discount rate is increasing. Second, similarly, the relationship between the USD/UAH exchange rate and the interbank lending rate is increasing. Third, the link between the CPI lag values and the official hryvnia exchange rate is increasing. Fourth, the relationship between the hryvnia against the US dollar and the NBU's interventions is insignificant. Fifth, there is a link between rising exports and the devaluation of the hryvnia against the US dollar. Keywords : exchange rate, transmission mechanism, monetary policy, exchange rate channel, discount rate.

Liquidity creation and funding ability during the interbank lending crunch

This study examines the portfolio response of US banks to the interbank lending collapse during the global financial crisis. The paper documents that a bank's response to the collapse of interbank markets is related to whether or not the bank was a net borrower or lender of funds. In particular, we find that typical borrowers had lower loan growth than typical lenders, but that the crisis did not differentially affect borrowers and lenders with respect to loan growth. However, borrowing and lending banks were differentially affected by the crisis in terms of their liquid asset growth. The typical borrowers reduced their liquid asset growth relative to lending banks during the crisis. We interpret this finding as saying that borrowing banks had to reduce their risky asset holdings because access to interbank funds had been reduced. The paper presents analogous analyses of the possible differential response of borrowers and lenders to changes in counterparty risk and lending through the Fed's TAF facility.

Liquidity Creation and Funding Ability During the Interbank Lending Crunch

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.

Dynamic interbank network analysis using latent space models

Longitudinal network data are increasingly available, allowing researchers to model how networks evolve over time and to make inference on their dependence structure. In this paper, a dynamic latent space approach is used to model directed networks of monthly interbank exposures. In this model, each node has an unobserved temporal trajectory in a low-dimensional Euclidean space. Model parameters and latent banks’ positions are estimated within a Bayesian framework. We apply this methodology to analyze two different datasets: the unsecured and the secured (repo) interbank lending networks. We show that the model that incorporates a latent space performs much better than the model in which the probability of a tie depends only on observed characteristics; in particular, the latent space model is able to capture the core-periphery structure of financial networks quite well, whereas the model without a latent space is unable to do so.

A Cooperative Model for Microgrids Based on Interbank Lending Method

To increase the microgrid’s (MG) profit and decrease the MG’s power loss, the cooperation between MGs has been studied. But there is lack of a specific mechanism for determining how to distribute alliance’s total profit to different MGs and an impact on balancing market’s cost. Hence, this paper firstly confirmed the electricity market mechanism. Then, established a model of direct transaction between MGs and main grid (DTMM) and proposed a model of cooperative transaction between MGs (CTM) based on interbank lending method. Finally, the paper used chronological simulation method to simulate the models proposed on MATLAB. Results showed that all MGs’ profit increased by 359160 € and the balancing market’s cost decreased by 91% in CTM compared with DTMM.

Network model of credit risk contagion in the interbank market by considering bank runs and the fire sale of external assets

We construct a network model of credit risk contagion in the interbank lending market based on time series. Such network model is based on imperfect information considering that the initial credit default of the debt bank will cause the creditor bank to run on its debt bank and the debt bank’s fire sale of external assets held to repay the debt or control the leverage ratio that reduce asset prices and create spillovers. By the theoretical deduction and simulation method, we study how the contagion effects of credit risk accumulate and spread in the interbank market network. In addition, we study the evolution characteristics of credit risk contagion caused by the initial default of debt banks in the interbank market. The following are the results of the study. First, when banks sell external assets at a fixed price, the fire sale of external assets can effectively reduce the probability of credit default. However, when the price of external assets decrease with the increase of fire sales volume, banks’ fire sale of external assets will lead to more serious contagion spillover consequences than that of none of the banks’ selling strategies. Second, the panic of bank decision makers in the banking system has a nonlinear evolution characteristic of increasing and decreasing credit risk contagion. Third, the higher the proportion of banks’ liquid assets, the stronger their ability to resist credit risks. Last, the higher the proportion of banks’ interbank assets, the stronger the contagion effect of credit risk on the entire banking system.

The SER Spread Under the ECB Quantitative Easing

This paper discusses the effects of the ECB's asset purchase programmes (APPs) on the SER spread, while the main focus is given to detail intraday analysis of implementation of the Public Sector Purchase Programme (PSPP). The SER spread is perceived as an important indicator of trust in the Eurozone and its elevated level normally signals distortion and mistrust among commercial banks with a power to spill over into the whole financial sector. Recent development on markets and especially within monetary policy in the Eurozone could have impaired the ability of the SER spread to act as a proxy for global systemic risk. The SER spread in this study was constructed and calculated using relevant European financial data and the consequent analysis was made on intraday and high-frequency (HF) 2015-2017 data. The ECB's APP, mainly PSPP, together with other instruments of monetary policy have impact on both legs of the SER spread and this paper tries to identify and quantify the degree of this effect by detailed HF market data analysis. HF intraday approach analysis is also being implemented in order to identify which of the SER spread was decisive in determining the SER spread change in the first three years of the PSPP implementation. Whether it was the sovereign bond-based leg directly affected by the ECB's PSPP purchases or the interbank lending / STIR-based leg.

Loan maturity aggregation in interbank lending networks obscures mesoscale structure and economic functions

Since the 2007–2009 financial crisis, substantial academic effort has been dedicated to improving our understanding of interbank lending networks (ILNs). Because of data limitations or by choice, the literature largely lacks multiple loan maturities. We employ a complete interbank loan contract dataset to investigate whether maturity details are informative of the network structure. Applying the layered stochastic block model of Peixoto (2015) and other tools from network science on a time series of bilateral loans with multiple maturity layers in the Russian ILN, we find that collapsing all such layers consistently obscures mesoscale structure. The optimal maturity granularity lies between completely collapsing and completely separating the maturity layers and depends on the development phase of the interbank market, with a more developed market requiring more layers for optimal description. Closer inspection of the inferred maturity bins associated with the optimal maturity granularity reveals specific economic functions, from liquidity intermediation to financing. Collapsing a network with multiple underlying maturity layers or extracting one such layer, common in economic research, is therefore not only an incomplete representation of the ILN’s mesoscale structure, but also conceals existing economic functions. This holds important insights and opportunities for theoretical and empirical studies on interbank market functioning, contagion, stability, and on the desirable level of regulatory data disclosure.

Equal treatment under the Fed: Interest on reserves, the federal funds rate, and the ‘Third Regime’ of bank behavior

Since the latter part of 2018, the federal funds rate has been equal to or nearly equal to the interest rate on excess reserves (IOER). Correspondingly, the Fed has expressed a desire for increased interbank lending within its target range for the federal funds rate. This paper examines these developments within a model of bank behavior. We argue that the resulting spread between the federal funds rate and IOER during this time led banks to switch to a third regime, different from the zero-excess-reserves regime of pre-October 2008 or the zero-wholesale-loan regime of post-October 2008 up to the period described above. Comparative-statics results from general-equilibrium solutions show that within this third regime, in which banks choose positive quantities of excess reserves and wholesale loans, banks exhibit the strongest response in retail lending to changes in the federal funds rate and the IOER. This regime, though, also has the weakest response in retail lending to a quantitative easing-type policy. Extending the model to the interbank loan market reveals that in the interior solution regime, even when faced with large increases in exogenous loan demand, banks borrow from the interbank loan market only under restrictive conditions. Taken with previous findings, we argue that monetary policy can include the Fed choosing the federal funds rate-IOER spread to determine the regime within which it desires for banks to operate. In this regard, we offer a sketch of how the Fed can utilize monetary policy strategically to stabilize the macroeconomy during the next recession.

Financial Contagion in Core–Periphery Networks and Real Economy

The recent global financial crisis has revealed that borrowing and lending among banks and other financial intermediaries makes it possible for a shock to a single bank to spread through the entire system. One of the main sources of this chain-reaction is that financial intermediaries have come to indirectly hold many types of assets. Against this background, to provide a stylized representation of the interbank lending market, the present paper constructs a model in which banks’ liabilities form a core–periphery network. The model is then employed to simulate contagion in the network in the wake of the hypothesized insolvency of one of the banks. The main contributions of the analysis are as follows. First, the simulation shows that when asset prices declines as contagion spreads, the degree of contagion in response to an insolvency is significantly greater than when prices are assumed to be exogenous. Second, the core–periphery network analysis shows that insolvency increases non-monotonically in the strength of the links between core banks.