Liquidity provision and interbank market functioning in the Euro area

Full Title 
Lending-of-last-resort is as lending-of-last-resort does: Liquidity provision and interbank market functioning in the euro area

This paper investigates the impact of excess liquidity provision by the European Central Bank on the functioning of the overnight unsecured interbank markets from 2008 to 2014. We use data on interbank transactions derived from TARGET2 payments data for Germany, Italy, Spain, Greece and the euro area as a whole. Using a simple structural vector autoregression framework to identify causal links, and controlling for bank risk changes, we find that the impact of excess liquidity depends on the degree of sovereign stress of the country in which borrowing banks reside. Higher excess liquidity leads to a lower willingness to borrow in the interbank market by banks in non-stressed countries and a higher willingness to lend to banks in stressed countries.