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Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-Prime CrisisViral V. AcharyaNew York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance Ouarda Merroucheaffiliation not provided to SSRN April 27, 2012 NYU Working Paper No. FIN-11-033 Abstract: We study the liquidity demand of large settlement banks in the UK and its effect on the Sterling Money Markets before and during the sub-prime crisis of 2007-08. Liquidity holdings of large settlement banks experienced on average a 30% increase in the period immediately following 9th August, 2007, the day when money markets froze, igniting the crisis. Following this structural break, settlement bank liquidity had a precautionary nature in that it rose on calendar days with a large amount of payment activity and for banks with greater credit risk. We establish that the liquidity demand by settlement banks caused overnight inter-bank rates to rise, an effect virtually absent in the pre-crisis period. This liquidity effect on inter-bank rates occurred in both unsecured borrowing as well as borrowing secured by UK government bonds. Further, the effect was more strongly linked to lender risk than to borrower risk.
Number of Pages in PDF File: 78 working papers seriesDate posted: December 15, 2011 ; Last revised: April 30, 2012Suggested CitationContact Information
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