Interbank money markets play a fundamental role in financial systems, since they allow for the redistribution of liquidity between financial institutions. However, they can also be a channel through which problems in one institution can spread to the remaining ones. In particular, the potential for contagion stemming from interbank money markets is closely related with the pattern of interbank lending relationships. In this study, we characterize the Portuguese overnight interbank money market between 1999 and 2009 and analyze its inherent potential for contagion, based on bilateral interbank exposures.
Data:
We use a unique data set containing information about interbank operations settled through the TARGET (Trans-European Automated Real-Time Gross Settlement Express Transfer System) Portuguese component, between 1999 and 2009. The database includes information on 320,000 overnight money market operations, in the value of 23,363 billion EUR, for 772 different institutions, of which 69 are Portuguese.
Methods:
Given the availability of a unique data set – the data on transactions settled in the Portuguese large value payment system – we compute the a matrix of bilateral interbank exposures following Furfine’s approach [Furfine, C. (1999) The microstructure of the federal funds market, Financial Markets, Institutions and Instruments, 8, 24-44; Furfine (2001) Banks as monitors of other banks: evidence from the overnight federal funds market. The Journal of Business, 71, 33-57]. This approach allows us to infer the actual pattern of lending relationships, which would be ruled out by the application of an alternative approach, such as the maximum entropy method.
Results:
We find that: (i) the Portuguese overnight interbank money market is ruled out by a multiple money center structure, where some banks have, simultaneously, an important role as lenders as well as borrowers; (ii) although unlikely, the failure of one institution can have contagion effects, pushing others into failure. However, even under the most extreme assumptions, institutions that fail by contagion represent less than 10 per cent of the total banking systems assets. On the other hand, even if there are no contagious defaults, a foreign bank failure can have non-negligible knock-on effects under national banks. Yet, overnight interbank lending relationships do not represent in general a major threat to the stability of the Portuguese financial system.