The Portuguese interbank money market during the subprime crisis and sovereign debt crisis

Money markets were severely impaired by the financial crisis and subsequent sovereign debt crisis. During the summer of 2007, BNP Paribas suspended redemptions for three investment funds due to the uncertainty regarding structured products. This event triggered the first stage of the financial crises in the euro area and linked it to the subprime mortgage crisis in the US. Afterwards, interbank lending was disturbed and the sovereign debt crisis aggravated the problem as country risk became a significant part of bank risk. Ultimately, the unsecured interbank money market froze.

This work uses an algorithm to identify unsecured interbank loans traded and settled in TARGET2, in which at least one of the trading parties is a Portuguese bank. Identified loans have overnight and one-week maturities. Data show that from the start of 2005 to the end of 2013 there was a significant reduction in the overnight unsecured interbank money market, not only in absolute terms but also comparing with the activity in the longer maturity market: after the Portuguese request for financial assistance, overnight turnover decreased by 64% from before the turmoil. Moreover, data also shows a clear segmentation between domestic and cross-border market and a clear trend towards a closed interbank market. The same market segmentation is also visible in interest rates. Before the financial collapse domestic and cross-border prices had converged, implying that the Portuguese part of the market was integrated in the overall euro money market. Afterwards, interest rates increased above the benchmark in both markets and for both maturities with rates in the domestic market being persistently higher than those agreed upon through cross-border operations.

Click here to go to the paper by Sofia Saldanha.