Banks and Central Banks
Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM
- Chair: Arvind Krishnamurthy, Stanford University
The Effect of Central Bank Liquidity Injections on Bank Credit Supply
AbstractWe study the effectiveness of central bank liquidity injections in restoring bank credit supply following a wholesale funding dry-up. We combine the Italian credit registry with bank security-level holdings and analyze the transmission of the European Central Bank 3-year Long Term Refinancing Operation. Exploiting a regulatory change that expands the pool of eligible collateral, we show that banks more affected by the dry-up use the central bank liquidity to restore credit supply, while less affected banks to increase their holdings of high-yield government bonds. Unable to completely switch from affected banks during the dry-up, firms benefit from the intervention.
Lender of Last Resort Versus Buyer of Last Resort: Evidence From the European Sovereign Debt Crisis
AbstractIn summer 2011, elevated sovereign risk in Eurozone peripheral countries increased the solvency risk of Eurozone banks, precipitating a run on their short-term debt. We assess the effectiveness of different European Central Bank (ECB) interventions that followed -- lender of last resort vs. buyer of last resort -- in stabilizing the European financial sector. We find that (i) by being lender of last resort to banks via the long-term refinancing operations (LTRO), ECB temporarily reduced funding pressure for banks, but did not help to contain sovereign risk. In fact, banks of the peripheral countries used the public funds to increase their exposure to risky domestic debt, so that when solvency risk in the Eurozone worsened the run of private short-term investors from Eurozone banks intensified. (ii) In contrast, ECB's announcement of being a potential buyer of last resort via the Outright Monetary Transaction program (OMT) significantly reduced the bank-sovereign nexus. The OMT increased the market prices of sovereign bonds, leading to a permanent reversal of private funding flows to Eurozone banks holding these bonds.
Monetary Policy and Global Banking
AbstractGlobal banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often not denominated in the same currency. This leads to an FX exposure that banks need to hedge. If cross-currency flows are large, the hedging cost increases diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity.
- G2 - Financial Institutions and Services