International Financial Integration, Crises, and Monetary Policy: Evidence from the Euro Area Interbank Crises
Since the mid-1980s, international capital flows have increased due to improved cross-border financial integration. However, the greater interconnection has exacerbated the effect that adverse liquidity shocks may have upon the world’s financial system. In September 2008, the failure of Lehman Brothers, a U.S. investment bank, marked the peak of the global financial crisis, which central banks combated using new and unprecedented policy measures. By early 2010, another crisis erupted in the euro area—due to concerns about sovereign default in Greece, Ireland, and Portugal and the health of Spain’s banking sector (collectively, the GIPS countries)—that prompted the European Central Bank (ECB) to engage in repeated rounds of intervention over a multi-year period. Despite the importance of understanding how financial crises affect cross-border lending channels, and whether the new and expansionary nonstandard monetary policy actions have helped repair financial markets, there is a dearth of empirical analysis on this topic due to a lack of micro-level data.
This paper uses a new and comprehensive micro-credit dataset on euro-denominated overnight loans in the interbank market, analyzed at the lender-borrower level, during the periods surrounding the Lehman Brothers’ failure and the European sovereign debt crisis. By comparing loans made to the same borrower on the same day that differ only by whether the lender is a foreign or a domestic bank, the authors identify the cross-border effects that are masked when data is aggregated at the bank or country level. This approach helps identify the factors that contribute to the reduction in cross-border lending and assess to what extent nonstandard expansionary monetary policies help to mitigate cross-border frictions that inhibit the supply of credit.