Money Markets and Bank Lending: Evidence from the Tiering Adoption

Abstract

Exploiting the introduction of the ECB’s tiering system for remunerating excess reserve holdings, we document the importance of money market participation for bank lending. We show that the two-tier system encouraged banks to participate in the money market to obtain liquidity. This ultimately decreased money market fragmentation, allowing banks to ensure themselves against future liquidity shocks. We provide evidence that improved money market relationships reduce the precautionary behavior of financially constrained banks, which consequently extend more credit.

Keywords: money market; bank lending; negative interest rate policy

JEL Classification: G2; E5