Abstract

Co-authors: Angelo Ranaldo (University of St. Gallen), Jan Wrampelmeyer (University of St. Gallen)

In the aftermath of the recent financial crisis, policy makers and regulators have initiated enormous efforts to reform financial markets in general and to stabilize banks’ funding in particular. Is there a market design for short-term funding that ensures that banks can satisfy their liquidity needs even during severe crisis periods like the 2007-2009 financial crisis or the European sovereign debt crisis? Can a well-designed private market encourage lending even when aggregate risk is large and overall funding conditions tighten? This paper shows that such a private funding market already exists, namely the central counterparty (CCP)-based euro interbank repo market. Using a unique and comprehensive dataset, we provide the first systematic study of this important funding market and show that it is resilient during crisis episodes. If the CCP -based infrastructure is combined with very safe collateral, the market even acts as a shock absorber, in the sense that repo volume increases with risk, while spreads, maturities, and haircuts remain stable. Our results are consistent with banks trusting the CCP -based repo market to be a safe venue to hoard liquidity.