When the Rivers Run Dry: Liquidity and the Use of Wholesale Funds in the Transmission of the U.S. Subprime Crisis

Abstract

This paper provides systematic evidence of the role of banks' reliance on wholesale funding in the international transmission of the ongoing financial crisis. It conducts an event study to estimate the impact of the liquidity crunch of September 15, 2008, on the stock price returns of 662 individual banks across 44 countries, and tests whether differences in the abnormal returns observed around those events relate to these banks' ex-ante reliance on wholesale funding. Globally and within countries, banks that relied more heavily in non-deposit sources of funds experienced a significantly larger decline in stock returns even after controlling for other mechanisms. Within a country, the abnormal returns of banks with high wholesale dependence fell about 2 percent more than those of banks with low dependence during the three days following Lehman Brothers' bankruptcy. This large differential return suggests that liquidity played an important role in the transmission of the crisis.

Keywords: Banks & Banking Reform, Debt Markets, Access to Finance, Financial Intermediation, Emerging Markets