Interbank borrowing and bank liquidity risk

To avoid illiquidity spillovers and basis risk in swaps, interbank lenders are especially cautious about whether interbank borrowers can meet their claims. We examine whether the incentive of interbank lenders to penalize risky borrowers can reduce borrowers' liquidity risk taking. We find that...

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Bibliographic Details
Published in:The Journal of financial research 2022, Vol.45 (1), p.53-91
Main Authors: Li, Zongyuan, Lai, Rose Neng
Format: Article
Language:English
Subjects:
Interbank Market
Liquidity Risk
Market Discipline
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Summary:To avoid illiquidity spillovers and basis risk in swaps, interbank lenders are especially cautious about whether interbank borrowers can meet their claims. We examine whether the incentive of interbank lenders to penalize risky borrowers can reduce borrowers' liquidity risk taking. We find that interbank borrowers, especially small and medium banks, manage their liquidity risks more prudently than their counterparts. This phenomenon is especially significant for borrowers with high information asymmetry, low liquidity buffers, and high funding gaps. Our results suggest that interbank exposure reduces the asset, funding, and off‐balance‐sheet liquidity risks of small and medium borrowing banks, and can therefore supplement regulatory liquidity requirements, which target only the largest banks.
ISSN:0270-2592
1475-6803
DOI:10.1111/jfir.12268