The functioning of the European interbank market during the 2007-08 financial crisis

This paper analyses the functioning of the overnight unsecured euro money market during the ongoing crisis in terms of i) operational efficiency of monetary policy implementation, ii) efficient reallocation of banking system’s reserves, iii) developments in the pricing of interbank loans. The results suggest that monetary policy implementation has been hampered by the crisis, particularly after the end of September 2008. A heightened awareness of counterparty credit risk seems to be one key factor behind the downward pressure on unsecured rates, as well as behind the notable increase in their cross-section dispersion. Starting from September 2008, and even more in October 2008, banks perceived as relatively “riskier” pre-turmoil paid significantly higher interest rates to borrow overnight funds. In November, a non-uniform softening of the strains occurred: only the most active (roughly the largest) borrowers experienced a notable price improvement. This is possibly a reflection of the bailouts of “too-big-to-fail” institutions. Heterogeneous developments in banks’ funding costs also suggest a move against the integration of the euro interbank market.