The Great Liquidity Freeze: What Does it Mean for International Banking?

35 Pages Posted: 24 Jun 2011

See all articles by Dietrich Domanski

Dietrich Domanski

Bank for International Settlements (BIS)

Philip Turner

University of Basel; National Institute for Economic and Social Research, London

Date Written: 2011

Abstract

In mid-September 2008, following the bankruptcy of Lehman Brothers, international interbank markets froze and interbank lending beyond very short maturities virtually evaporated. Despite massive central bank support operations and purchases of key assets, many financial markets remained impaired for a long time. Why was this funding crisis so much worse than other past major bank failures and why has it proved so hard to cure? This paper suggests that much of that answer lies in the balance sheets of international banks and their customers. It outlines the basic building blocks of liquidity management for a bank that operates in many currencies and then discusses how the massive development of foreign exchange (forex) and interest rate derivatives markets transformed banks’ strategies in this area. It explains how the pervasive interconnectedness between major banks and markets magnified contagion effects. Finally, the paper provides some recommendations for how strategic borrowing choices by international banks could make them more stable and how regulators could assist in this process.

Keywords: banking financial stability, financial markets, international banking, international interbank markets, liquidity management

JEL Classification: E44, G01, G15, G18, G24, G28

Suggested Citation

Domanski, Dietrich and Turner, Philip, The Great Liquidity Freeze: What Does it Mean for International Banking? (2011). ADBI Working Paper No. 291, Available at SSRN: https://ssrn.com/abstract=1871706 or http://dx.doi.org/10.2139/ssrn.1871706

Dietrich Domanski (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Philip Turner

University of Basel ( email )

Petersplatz 1
CH-4001 Basel
Switzerland

National Institute for Economic and Social Research, London ( email )

2 Dean Trench St
London, SW1P 3HE
United Kingdom

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