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Precautionary Hoarding Of Liquidity And Inter-Bank Markets: Evidence From The Sub-prime Crisis

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Executive Summary

The paper consists of three pieces. First, the authors document that liquidity holdings of the large settlement banks in the UK experienced on average a 30% increase in the period immediately. Second, they show that following this structural break, bank liquidity had a precautionary nature in that it rose on calendar days predicted to have a large amount of fluctuations in payment and settlements activity and more so for banks that made larger losses during the crisis. Third, using the payment and settlements activity as an instrument, they establish a causal effect of bank liquidity on overnight inter-bank rates, in both secured and unsecured markets, an effect that is virtually absent in the period before the crisis.

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