Do Central Bank Interventions Limit the Market Discipline from Short-Term Debt?

In this paper, we investigate the impact of European Central Bank (ECB) interventions on the private short-term funding of European banks and asset prices of sovereign bonds and bank stocks during the sovereign debt crisis. We show that consistent with a market discipline role of wholesale funding runs, the U.S. money market funds reduced unsecured funding for risky banks during summer 2011, and increased unsecured and repo funding to low risk non-Eurozone banks. This market discipline effect of risk on funding liquidity is reversed with a series of ECB interventions; Eurozone risky banks gain access to repos during the period of interventions, and recover part of their unsecured funding after the intervention period. Short-term funding flowing back to risky banks coincides with increasing sovereign bond prices of peripheral countries. Event studies around ECB intervention dates support this: We find that banks with large Greece, Italy, Ireland, Portugal, and Spain (GIIPS) holdings experience abnormal stock returns and get increased access to U.S. MMF following ECB interventions.