Interbank lending market is a market where banks extend lending to each other for a certain period of time. Most interbank loans are for a period of one week or less, the majority overnight. The loan is performed at interbank rate (also called overnight rate if the loan term is overnight). The sharp decline in transaction volume in this market was a major factor contributing to the collapse of several financial institutions during the 2007 financial crisis.
Banks are required to have sufficient amount of liquid assets, such as cash, to manage any potential bank run by clients. If the bank can not meet this liquidity requirement, it is necessary to borrow money on the interbank market to cover the shortfall. Some banks, on the other hand, have excess liquid assets above and beyond liquidity requirements. These banks will lend money on the interbank market, receiving interest on assets.
Interbank interest rate is the interest rate charged on short-term interbank loans. Banks borrow and lend money on the interbank loan market to manage liquidity and meet regulations such as reserve requirements. The interest rate charged depends on the availability of money in the market, at the prevailing rate and on the specific terms of the contract, such as the term. There are various interbank interest rates published, including federal funds (US), LIBOR (UK) and Euribor (Eurozone) rates.
Video Interbank lending market
Interbank segment of the money market
The interbank lending market refers to a subset of bank-to-bank transactions taking place on the money market.
Money markets are part of the financial markets where funds are lent and borrowed for a period of one year or less. Funds are transferred through the purchase and sale of money market instruments - highly liquid short-term debt. This instrument is considered a cash equivalent because it can be sold in the market easily and at a low cost. They are generally published in units of at least a million and tend to have a maturity of three months or less. Because the active secondary market exists for almost all money market instruments, investors can sell their holdings before maturity. The money market is an over-the-counter (OTC) market.
Banks are major players in some money market segments. To meet reserve requirements and manage day-to-day liquidity requirements, banks buy and sell short-term uncollateralized loans in the federal funds market. For longer-term loans, banks can take advantage of the Eurodollar market. Eurodollars are a dollar-denominated liabilities of banks located outside the United States (or International Banking Facilities in the United States). US banks can raise funds in the Eurodollar market through overseas branches and their subsidiaries. The second option is to issue a negotiable certificate of deposit (CD). This is a certificate issued by the bank stating that the specified amount of money has been deposited for a specified period of time and will be redeemed at interest at maturity. The repurchase agreement (repo) is another source of funding. Repos and reverse repos are transactions in which the borrower agrees to sell securities to the lender and then repurchases the same or similar securities after a certain time, at a specified price, and includes interest at an agreed rate. Repo secured or secured loans differ from unsafe federal funds loans.
Maps Interbank lending market
The role of interbank loans in the financial system
To support the fractional backup banking model
The creation of credit and transfer of funds made to other banks, creating the need for lenders' banks to borrow to cover the terms of short-term withdrawal (by depositors). This results from the fact that the funds that were originally made have been transferred to another bank. If there is (conceptually) only one commercial bank then all new credits (money) made will be deposited in the bank (or held as outside money) and the requirements for interbank loans for this purpose will be reduced. (In the fractional reserve banking model it will still be necessary to address the 'run' issue in the bank concerned).
Sources of funds for banks
Interbank loans are essential to a well-functioning and efficient banking system. Because banks are subject to regulations such as reserve requirements, they may face a liquidity shortage by the end of the day. The interbank market allows banks to smooth out temporary liquidity shortages and reduce 'funding liquidity risk'.
Funding liquidity risk
Funding liquidity risk captures the inability of financial intermediaries to serve its obligations when it matures. This type of risk is highly relevant to banks because their business model involves funding long-term loans through short-term deposits and other liabilities. The healthy functioning of the interbank loan market can help reduce the risk of liquidity funding because banks can obtain loans in this market quickly and at low cost. When interbank markets are dysfunctional or tense, banks face greater liquidity funding risks that in extreme cases can lead to bankruptcy.
Long-term trends in bank resources
In the past, checkable deposits were the most important source of funds from US banks; in 1960, checkable deposits accounted for more than 60 percent of total bank liabilities. Over time, however, the bank's balance sheet composition has changed significantly. As a substitute for customer deposits, banks are increasingly turning to short-term liabilities such as commercial paper (CP), certificates of deposit (CD), repurchase agreements, foreign exchange liabilities, and brokered deposits.
Benchmark for short term loan rate
Interest rates on the unsecured lending market serve as reference levels in pricing of various financial instruments such as floating rate notes (FRN), adjusted interest rates (ARM), and syndicated loans. This benchmark rate is also commonly used in the analysis of corporate cash flows as a discount rate. Thus, conditions on the unsecured interbank market can have broad effects in the financial system and the real economy by influencing the investment decisions of firms and households.
Efficient market functionality for such instruments depends on stable and stable reference levels. The benchmark interest rate used to fix the price of many US financial securities is the three-month US dollar Libor rate. Until the mid-1980s, Treasury billing rates were the primary reference level. However, it eventually loses its benchmark status to Libor due to price volatility caused by large and periodic changes in the provision of bills. In general, offshore reference levels such as Libor US dollar rates are preferred over onshore benchmarks because the former tend to be undistorted by government regulations such as capital controls and deposit insurance.
Transmission of monetary policy
Central banks in many countries apply monetary policy by manipulating the instruments to achieve certain values ​​of the operating target. Instruments refer to variables directly controlled by the central bank; examples include reserve requirements, the interest rate paid on funds borrowed from the central bank, and the balance sheet composition. Target operations are usually the size of bank reserves or short-term interest rates such as interbank overnight rates. These targets are set to achieve certain different policy goals across the entire central bank depending on their specific mandate. 1
US federal funds market
Implementation of US monetary policy involves intervening in the unsecured interbank lending market known as the fed fund market. Federal funds (fed funds) are non-borrowed reserve balance loans in Federal Reserve banks. The majority of loans in the money market eat overnight, but some transactions have more maturity. The market is an over-the-counter (OTC) market where the parties negotiate loan terms either directly with one another or through a food fund broker. Most of these overnight loans are booked without a contract and consist of oral agreements between parties. Participants in the feeding market include: commercial banks, savings and loan associations, foreign bank branches in the US, federal agents, and major dealers.
Storage agencies in the US are subject to reserve requirements, regulations set by the Federal Reserve Board of Governors that require banks to deposit certain amounts (reserves) in their accounts at the Fed as insurance against outflows of deposits and other balance sheets. fluctuations. It is common for banks to end up with too much or too little reserves in their accounts at the Fed. As of October 2008, banks have an incentive to lend unemployed funds because the Fed is not paying interest on excess reserves
Interest rate channel from monetary policy
The monetary policy interest rate channel refers to the influence of monetary policy actions on interest rates that affect investment decisions and household and business consumption. Throughout this channel, the transmission of monetary policy to the real economy depends on the relationship between central bank instruments, operating targets, and policy goals. For example, when the Federal Reserve conducts open market operations in federal funds markets, the manipulated instrument is its ownership of government securities. The Fed's operating target is the overnight federal funds rate and its policy targets are maximum employment, stable pricing, and moderate long-term interest rates. In order for the interest rate channel from monetary policy to work, open market operations must affect the level of federal funds overnight which should affect the lending rates given to households and businesses.
As explained in the previous section, many US financial instruments are actually based on the US dollar Libor level, not the effective federal funds rate. Successful monetary policy transmission requires a link between the Fed's operating target and the interbank lending interest rate such as Libor. During the 2007 financial crisis, the weakening of this relationship posed a major challenge for the central bank and was one of the factors that motivated the creation of liquidity and credit facilities. Thus, conditions in the interbank lending market can have important effects on the implementation and transmission of monetary policy.
Tension on the interbank lending market during the 2007 financial crisis
In mid-2007, cracks began to appear in the market for asset-backed securities. For example, in June 2007, rating agencies lowered more than 100 bonds backed by second-lien sub-prime mortgages. Soon afterwards, the investment bank Bear Stearns liquidated two hedge funds that had invested in mortgage-backed securities (MBS) and several large mortgage lenders filed for Chapter 11 bankruptcy protection. Tensions in the interbank lending market became clear on August 9, 2007, after BNP Paribas announced that it halted repayments on three of its investment funds. That morning the US dollar Libor rate rose more than 10 basis points (bps) and kept rising thereafter. Spread of US LIBOR-OIS ballooned to more than 90bps in September while averaging 10bps in the previous month.
At the following FOMC meeting (18 September 2007), the Fed began to ease monetary policy aggressively in response to the turmoil in financial markets. Within minutes of the September FOMC meeting, Fed officials characterize the interbank lending market as significantly disrupted:
"The Bank is taking steps to preserve their liquidity and be cautious about counterparties' exposure to asset-backed commercial paper The intermediate-term intermediate-term interbank fund market has declined significantly, with rates rising well above overnight rate forecasts and traders reporting a decline which is substantial in the availability of term funding. "
By the end of 2007, the Federal Reserve had cut its target rate of 100 bps and started some liquidity provisioning programs, but the Libor-OIS spread remained high. Meanwhile, for most of 2008, long-term funding conditions remain emphasized. In September 2008, when the US government decided not to rescue Lehman Brothers' investment bank, the credit market turned from tense to being completely broken and the Libor-OIS spread burst to over 350bps.
Possible explanation
Increased counterparty risk
The increased risk of counterparty reduces the lending of bank borrowers expected from providing unsecured funds to other banks and thereby lowering their incentives to transact with one another. This is the result of Stiglitz and Weiss (1981): the expected return of the loan to the bank is a declining function of loan riskiness. Stiglitz and Weiss also pointed out that an increase in funding costs could lead to safer borrowers to get out of the market, leaving the remaining remaining borrowers more risky. Thus, reverse selection may have exacerbated tensions in the interbank lending market after Libor rates have increased.
The market environment at that time was not consistent with the increased risk of counterparty and higher levels of information asymmetry. In the second half of 2007, market participants and regulators began to become aware of the risks in securities products and derivatives. Many banks are in the process of writing down the portfolio values ​​related to their mortgages. House prices are falling across the country and rating agencies have just started to reduce subprime mortgages. Concerns about structured investment vehicles (SIV) and mortgage insurance and bonds grew. In addition, there is a very high uncertainty about how to assess complex securities instruments and where within the financial system these securities are concentrated.
Hoarding of liquidity
Another possible explanation for seizing interbank loans is that banks stockpile liquidity to anticipate future shortages. Two modern features of the financial industry suggest this hypothesis does not make sense. First, banks increasingly rely on deposits as a source of funds and more on short-term wholesale funding (CD-mediated, asset-backed commercial paper (ABCP), interbank buy-back agreements, etc.). Many of these markets are under pressure during the early phase of the crisis, particularly the ABCP market. This means that the bank has fewer funding sources to target, although an increase in retail deposits during this period provides some offsets.
Secondly, it is common for companies to switch to markets rather than banks for short-term funding. In particular, before crisis companies regularly knock on the commercial paper market to raise funds. These companies still have credit lines with banks, but they use them more as insurance sources. However, after nearly the collapse of the commercial paper market, the company took advantage of this insurance and the bank had no choice but to provide liquidity. Thus, the use of corporate credit lines during the crisis increases the risk of liquidity for banks. Finally, off-balance sheet bank programs (SIV for example) rely on short-term ABCP to operate; when this market dries up, banks in some cases must take assets from these vehicles to their balance sheets. All these factors make liquidity risk management extremely challenging during this time.
List of interbank lending interest rates
United States
Effective federal funds rate
The effective rate of federal funds is the weighted average rate at which banks lend to each other in the overnight food market; also known as US overnight rates. Note that the effective interest rate of the fed funds is different from the target interest rate, which is the level decided by members of the Federal Open Market Committee when they meet several times a year to discuss monetary policy.
Libor US dollar rate
The US dollar Libor rate, short for the London interbank offering rate, is the rate at which banks indicate that they are willing to lend to other banks for a specified period of time. Previously, it was the average of the average British Bank Interbank rate for dollar deposits in the London market. However, tariff administration has been transferred to Intercontinental Exchange. The Libor Interest rate reflects the expected path of monetary policy as well as the risk premium associated with credit and liquidity risk.
Europe
In Europe, the interbank lending rate is called Euribor, published on the euribor-ebf website.
Shanghai
In Shanghai, the interbank lending rate is called SHIBOR, published on the SHIBOR website.
Hong Kong
In Hong Kong, the interbank lending rate is called HIBOR, issued by the Hong Kong Bank Association.
Australia
In Australia, the interbank lending rate is called the banknote exchange rate (BBSW).
See also
- The 2007 financial crisis
- Market liquidity
- Liquidity crisis
- Money market
- Libor
- Euribor
- Libor-OIS spreads
Note
1. For example, the Federal Reserve's policy goals include maximum employment, stable pricing, and moderate long-term interest rates while the Bank of England's mandate is to keep prices stable and to maintain confidence in the currency.
References
- Afonso, G, Anna Kovner and Antoinette Schoar (2010), "Stressed, not Frozen: The Federal Funds Market in Financial Crisis", Nberg Working Paper 15806.
- Angelini, Nobili, and Picillo (2009), "The interbank market after August 2007: what has changed and why?", Bank of Italy wrote paper number 731, October.
- Ashcraft, McAndrews, and Skeie (2009), "Precautionary Reserves and Interbank Markets", Federal Reserve Bank of New York's Staff Report, no. 370.
- Cook, Timothy, and Robert LaRoche (eds), "Money market instruments," Monographs, Federal Reserve Bank of Richmond.
- Federal Reserve Act. Section 2a. Monetary Policy Objectives. http://www.federalreserve.gov/aboutthefed/section2a.htm
- Gorton, G and A Metrick (2009), "Securitized Banking and the Run on Repo", Working Paper of NBER 15223.
- Bank of England. Monetary policy. http://www.bankofengland.co.uk/monetarypolicy/index.htm
- "IMF Global Financial Stability Report April 2008", International Monetary Fund.
- "IMF Global Financial Stability Report October 2008", International Monetary Fund.
- Mester, Loretta (2007). "Some Thoughts on the Evolution of the Banking System and Process of Financial Intermediation", the Federal Reserve Bank of Atlanta Economic Review.
- Michaud and Upper (2008), "What drives the interbank rate? Evidence from the Libor panel", BIS Quarterly Review, March 2008.
- Mishkin, Frederic S. Money Economy, Banking and Financial Markets . Addison Wesley, 2009.
- Taylor, JB and JC Williams (2009), "A Black Swan in Money Market", American Economic Journal: Macroeconomics, 1: 58-83.
External links
Source of the article : Wikipedia
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