Interbank Market Research Articles

The Determinants of Monetary Policy in Malaysia: Impact on Economic Activity

The overnight interbank rate is a key tool for central banks to influence economic activity and maintain financial stability. It represents the rate at which banks lend and borrow short-term funds from one another, often overnight, and plays a crucial role in monetary policy transmission. Changes in this rate can affect borrowing costs and credit availability, which in turn impacts consumption, investment, and economic activity. Bank Negara Malaysia (2021) highlights that overnight transactions in the interbank market operate alongside the Kuala Lumpur Interbank Offered Rate (KLIBOR). This study analyzes time series data from 1991 to 2021 to identify relationships between the overnight interbank rate and macroeconomic variables using the ordinary least square (OLS) method. The analysis focuses on unemployment (UR), domestic private credit (DGR), gross domestic product (GDP), foreign exchange reserves (FER), and inflation (I), with data sourced from the World Bank and the Federal Reserve Bank (FRED). The results show that unemployment and inflation significantly impact monetary policy. High unemployment suggests underused resources, often prompting lower interest rates to stimulate investment and economic growth. In contrast, rising inflation typically leads central banks to increase interest rates to slow spending, while falling inflation may result in rate cuts to spur economic activity.

Fiscal Stimulus, Deposit Competition, and the Rise of Shadow Banking: Evidence from China

The rise of shadow banking and attendant financial fragility in China can be traced to intensified deposit competition following the 2008–2009 global financial crisis (GFC). A large, state-owned bank’s deposits from cross-border money inflows fell significantly following the GFC, and it supported the government’s fiscal stimulus more aggressively than other large banks by issuing larger volumes of new loans. Small and medium-sized banks with more branch-level overlaps with this large bank relied more on shadow banking and issued more wealth management products (WMPs)—short-maturity, off-balance-sheet substitutes for deposits. Greater amounts of WMPs created rollover risks for the issuers, as reflected by higher yields on new WMPs, higher borrowing rates in the interbank market, and lower stock-market performance during liquidity stress. This paper was accepted by Victoria Ivashina, finance. Funding: This work was supported by the National Natural Science Foundation of China [Grants 71272024, 71972051, and 72071117]. Supplemental Material: The internet appendix and data files are available at https://doi.org/10.1287/mnsc.2023.04233 .

The Demand for Real Money Balances in Zimbabwe: An Error Correction Estimation

Purpose: The purpose of the study is to examine the stability of the money demand function in Zimbabwe. Understanding, the money demand function is a prerequisite for effective monetary policy formulation and understanding the monetary transmission process and shocks propagation in the economy. Materials and Methods: The study employs the error correction modeling methodology to investigate the money demand function for Zimbabwe using quarterly data from 2017q2 – 2023q2. The analysis is expanded to characterize the monetary transmission mechanism following a shock to the price level and how the demand for real money balances responds to both single period and multiple shocks. Findings: The findings confirm a stable long run money demand function that is subject to short run dynamics. In addition, real money demand responds positively to real GDP (Scale factor) and inversely related to the price level (inflation). Short term dynamics (particularly inflation expectations) compound real money demand collapse in response to rising inflation. Implications to Theory, Practice and Policy: Monetary Policy must aim to collapse inflation expectations through a tight monetary control program and a functioning interbank market for foreign exchange to avoid surging parallel market activity.

Deep Heterogeneous AutoML Trend Prediction Model for Algorithmic Trading in the USD/COP Colombian FX Market Through Limit Order Book (LOB)

This study presents a novel and competitive approach for algorithmic trading in the Colombian US dollar inter-bank market (SET-FX). At the core of this strategy is an advanced predictive model, developed using the Tree-based Pipeline Optimization Tool (TPOT). TPOT, an automated machine learning platform based on strongly-typed genetic programming, incorporates the Non-dominated Sorting Genetic Algorithm II (NSGA-II). This multi-objective evolutionary algorithm is instrumental in identifying machine learning models that strike an optimal balance between high accuracy and low complexity, thereby advancing the field of predictive modeling in financial markets.

Aggregate Risk and Lending Decisions in the Interbank Market

AbstractWe introduce a novel measure of the market‐wide rik of the interbank market: the total (across all banks) uncollateralized/collateralized lending volume ratio: . This measure is based on the intuition that lender banks should use less (more) uncollateralized (collateralized) lending when aggregate risk increases, after controlling for banks’ features and market conditions that might affect (e.g., banks’ credit risk, cross‐border inflows, supply–demand heterogeneity, and funding costs, among others). This is because collateralized loans are safer than uncollateralized ones after an interbank market‐wide collapse. Actually, we show that modifies the future lending decisions and net lending holdings of individual banks.

Who Can Tell Which Banks Will Fail?

Abstract We study the run on the German banking system in 1931 to understand whether depositors anticipate which banks will fail in a major financial crisis. We find that deposits decline by around 20% during the run. There is an equal outflow of retail and nonfinancial wholesale deposits from both failing and surviving banks. In contrast, we find that interbank deposits almost exclusively decline for failing banks. Our evidence suggests that banks are better informed about which fellow banks will fail. In turn, banks being informed allows the interbank market to continue providing liquidity even during times of severe financial distress.

Competition, coinsurance and moral hazard in banking

This study examines the interaction between bank deposit market competition, incentives to take risks on the asset side, and willingness to participate in the interbank market for liquidity coinsurance. The interbank market in the model has two countervailing effects on risk-taking. First, it allows for more profitable long-term investment, which adds to a bank’s charter value and decreases risk-taking motives. Second, greater investment in the long-term asset also makes risk-taking potentially more profitable, thus eroding charter value. Finally, risk-taking motives also influence banks’ decisions to participate in the interbank market. We demonstrate how a combination of capital requirements and posting a surety bond can restore charter value, promote cooperation and boost economic activity. Additionally, this measure does not limit competition in generating charter value and implies lower costs than capital requirements alone.

The Impact of Fed's Interest Rate Hike on RMB Exchange Rate: Based on Stepwise Regression Modelling

In the late stage of the epidemic, the Federal Reserve raised interest rates several times in a row in response to domestic inflation, which had a significant impact on the international financial environment, as exemplified by the fluctuation of the RMB exchange rate. Although several worldwide and domestic scholars have used various models to study the relationship between them, there are no studies that have used linear regression models t to clarify how the two are connected. This study uses stepwise regression on the basis of linear regression to establish an optimal model for studying RMB exchange rate fluctuations and the Fed's monetary policy adjustment, which fills this research gap. It is found that Fed rate hikes cause the RMB exchange rate to decline., while the RMB exchange rate is also negatively affected by the seven-day repo rate in China's interbank market and the People's Bank of China's foreign exchange reserves. Therefore, this study concludes by recommending that investors, Chinese foreign trade firms and People’s bank of China take appropriate measures to minimize the impact of RMB depreciation in anticipation of the Fed's interest rate hike.

Assessing the Effectiveness of Advertising Costs in the Banking Sector

In recent years, clients of Russian banks have learned to take into account changes in the financial market quickly. When the key rate changes, they change their strategy — the demand for annual deposits decreases, and the flow of funds for short-term deposits increases. It doesn't contradict the interests of the banking sector. At a high level of the refinancing rate on the interbank market, the credit institution is interested in increasing the money supply on deposits. Attracting customers is carried out by banks using a variety of marketing tools, the main of which remains advertising. None of the tools for the bank is free of charge and a traditional economic problem arises: to put in the budget minimal costs for advertising and get a large the effect. It is obvious that in such a formulation the problem is unsolvable. Therefore, currently the theory offers only a single approach to assessing the effectiveness of advertising costs, which the authors call «traditional». Its disadvantage refers to the fact that the generated effect is difficult to divide into impact components, since not only advertising affects the flow of new customers and the share of loyal ones. The approach proposed by the authors makes it possible to assert that the use of an econometric method in management analysis in addition to the traditional method of assessing the effectiveness forms an evidence base for justifying advertising costs by banks. The article reflects the results of the study using the example of JSC «Raiffeisenbank». The advantage of the proposed method is the availability of information: the study is based only on open data published on the website of the Bank of Russia. This will allow Russian commercial banks to assess cost effectiveness after advertising campaigns and during their planning as well as compare the level of effectiveness with competitors.

Interbank Decisions and Margins of Stability: an Agent-Based Stock-Flow Consistent Approach

This study investigates the functioning of modern payment systems through the lens of banks' maturity mismatch practices, and it examines the effects of banks' refusal to roll over short-term interbank liabilities on financial stability. Within an agent-based stock-flow consistent framework, banks can engage in two segments of the interbank market that differ in maturity, overnight and term. We compare two interbank matching scenarios to assess how bank-specific maturity targets, dependent on the dictates of the Net Stable Funding Ratio, impact the dynamics of the interbank market and the effectiveness of conventional monetary policies. The findings reveal that maturity misalignment between deficit and surplus banks compromises the interbank market's efficiency and increases reliance on the central bank's standing facilities. Monetary policy interest-rate steering practices also become less effective. The study also uncovers a dual stability-based configuration in the banking sector, resembling the segmented European interbank structure. This paper suggests that heterogeneous maturity mismatches between surplus and deficit banks may result in asymmetric funding frictions that might precede credit- and sovereign-risk explanations of interbank tensions. Also, a combined examination of macroprudential tools and rollover-based interbank dynamics can enhance our understanding of how regulatory changes impact the stability of heterogeneous banking sectors.

Counterparty choice, maturity shifts and market freezes: Lessons from the European interbank market

We explore the impact of relationship lending on the interbank debt maturity structure of banks using data from the e-MID market covering both pre- and post-Lehman periods. We study the term structure and maturity shortening of interbank lending as an indicator of risk in times of stress. We identify bank-level and pair-level variables which are shown to contain information about the behaviour of lending relations during times of stress. Using a two-part fractional response model we show that durable liquidity relationships increase the probability of contracting term loans, but do not prevent maturity shortening during periods of acute stress. Finally, we find that lenders with concentrated short-term interbank liability structure tend to reduce their own long term lending, which confirms the rollover risk viewpoint of term interbank market freeze. Our findings are relevant for the modelling of interbank networks under stress and the design of forward looking stress tests for the banking system.

Does Adaptive Learning Neutralize Interbank Market Liquidity Hoarding under a Distressed Market Condition?

Does Adaptive Learning Neutralize Interbank Market Liquidity Hoarding under a Distressed Market Condition?

Розробка індексу кредитних стандартів в Україні за допомогою впорядкованих логістичних моделей

This study expands the understanding of the dynamics of credit standards in Ukraine. This publication makes an important contribution to the analysis of the supply of bank lending. A panel ordered logit model was used to build the Credit Standards Index (CRI) for different market segments. The study uses survey data on bank lending conditions at the bank level, which makes it unique, as this data is usually used at the aggregated level. The accuracy of the model is 65% for corporate loans, 84.4% for mortgages, and 77.6% for consumer loans. It is found that at the system level, banks in Ukraine tightened corporate lending standards during the crises in 2014–2015 and 2022, while standards for mortgages and consumer loans were tightened only in 2022. Based on the results of the simulation, it is determined that banks weakened lending standards only for consumer loans in 2021. It is found that the model weakly classifies banks that have softened or strengthened corporate lending standards, but for mortgages and consumer loans, the results are noticeably better. The increase in interest rates in the interbank market affects the tightening of credit standards for corporate loans. According to the results of the study, real GDP growth contributes to the weakening of standards for corporate and mortgage loans. Competition between banks may weaken standards for all market segments, but strengthen them for mortgages. Expectations of the prospects for the real estate market affect both the strengthening and weakening of mortgage lending standards. In the field of consumer lending, borrowers’ solvency expectations determine the change in credit standards in both directions. The results are important from the standpoint of using the index to study the determinants of lending in Ukraine, as the index approximates the supply of banks, which is an unobservable variable.

COVID-19 and the Fragmentation of the European Interbank Market

COVID-19 and the Fragmentation of the European Interbank Market

The formation of interbank interest rates and treasury bill yields in Japan under different regimes of non‐traditional monetary policy

AbstractInterbank interest rates and Treasury Bill (TB) yields of maturities of three and six months move together, but not 12 months, under a “quantitative and qualitative easing policy.” On the other hand, interbank interest rates and TB yields of maturities of 3, 6, and 12 months move together under a “negative interest rate policy.” Interbank and TB markets are partially integrated up to the 6‐month maturity as a short‐term money market under a “quantitative and qualitative easing policy,” while interbank and TB markets are integrated up to the 12‐month maturity as a short‐term money market under a “negative interest rate policy.” This indicates that the arbitrage of interbank and TB markets works. Practitioners of the interbank market are limited to financial institutions, but those of TB markets also include non‐financial institutions.

Reservation Rates in Interbank Money Markets

AbstractThis paper proposes a dyadic econometric model with reservation rates to control for endogenous matching in interbank money markets. We apply our method to a unique data set and study the interbank market during the European sovereign debt crisis. The estimates uncover the existence of reservation rates, their omission can bias important quantities like the discount enjoyed by big banks, a potential measure of the “too‐big‐to‐fail” subsidy. We test predictions of various theories on the interbank market. The market did not freeze completely during the crisis and active peer monitoring was still in place under limited information asymmetry. Dispersion in rates and liquidity hoarding was driven by banks' nationality, regardless of the borrower quality.

Practical Experience and Enlightenment of Sustainable Financial Development in the European Union

Currently, developing green finance and serving a green economy has become a global consensus. The European Union's (EU) sustainable finance has an early origin, rich development experience, and a relatively complete framework system. The EU Action Plan: Financing Sustainable Development provides strong guidance to promote sustainable finance, and this initiative stimulates interbank market regulators to act quickly to achieve the goal of sustainable development. Additionally, Through the plan, European standards for green finance business have been unified, which has dramatically improved the efficiency of green finance in the interbank market and helped to facilitate effective convergence among financial institutions. The EU's sustainable financial system has an extremely excellent hierarchy, clear guidelines, a solid foundation, and profound influence, and it provides important guidance and reference for the development of green finance in China.

Dimensional reduction of solvency contagion dynamics on financial networks

Modelling systems with networks has been a powerful approach to tame the complexity of several phenomena. Unfortunately, the large number of variables to take into consideration often makes concrete problems difficult to handle. Methods of dimensional reduction are useful tools to rescale a complex network down to a low-dimensional effective system and thus to capture its global dynamical features. Here we study the application of the degree-weighted and spectral reduction methods to an important class of dynamical processes on networks: the propagation of credit shocks within an interbank network, modelled according to the DebtRank algorithm. We introduce an effective version of the dynamics, characterized by functions with continuous derivatives that can be handled by the dimensional reduction. We test the reduction methods against the full dynamical system in different interbank market settings: homogeneous and heterogeneous networks generated from state-of-the-art reconstruction methods as well as networks derived from empirical e-MID data. Our results indicate that, for proper choices of the bank default probability, reduction methods can provide reliable estimates of systemic risk in the market, with the spectral reduction better handling heterogeneous networks. Finally, we provide new insights on the nature and working principles of dimensional reduction methods.

A financial supply chain on corporate working capital and interbank lines of credit

Companies sign prior contracts for working capital demand loans with banks to mitigate their working capital shortfall. In order to honor the contract, banks also undertake lines of credit agreements in the interbank market to protect themselves from liquidity mismatch. The paper proposed a mathematical model to assess the performance of banks in a probabilistic environment, where corporates exercise their options for working capital loans and banks face liquidity problems, therefore resort to lines of credit in the interbank market. The paper through simulation examined the effect of expected income and expenses, at different probabilities for companies exercising their options for different quantities of working capital demand loans, and banks approaching the interbank market for lines of credit. It is found that as the probability of exercising working capital demand loans increases, the net-interest income for banks also increases. The model is further validated with unique primary data for a bank having overdraft contracts with 55 companies in an interbank market of 22 banks. The paper uses the network theory to examine the stability of banks in an interbank market. This model will help banks with policy formulations to maximize net-interest income by considering the number of corporates signing overdraft contracts, overdraft interest rate, the probability of corporates exercising overdraft contracts, and the number of banks to be considered in an inter-bank market.

Options on Interbank Rates and Implied Disaster Risk

The identification of disaster risk has remained a significant challenge due to the rarity of macroeconomic disasters. We show that the interbank market can help characterize the time variation in disaster risk. We propose a risk-based model in which macroeconomic disasters are likely to coincide with interbank market failure. Using interbank rates and their options, we estimate our model via MLE and filter out the short-run and long-run components of disaster risk. Our estimation results are independent of the stock market and serve as an external validity test of rare disaster models, which are typically calibrated to match stock moments.