Morten L. Bech

The topology of the federal funds market

We explore the network topology of the federal funds market. This market is important for distributing liquidity throughout the financial system and for the implementation of monetary policy. The recent turmoil in global financial markets underscores its importance. We find that the network is sparse, exhibits the small-world phenomenon, and is disassortative. Centrality measures are useful predictors of the interest rate of a loan.

The intraday liquidity management game

Abstract We use a game theoretical framework to analyze the intraday behavior of banks with respect to settlement of interbank claims in a real-time gross settlement setting. The game played by banks depends upon the intraday credit policy of the central bank and it encompasses two well-known game theoretical paradigms: the prisoners dilemma and the stag hunt. The former arises in a collateralized credit regime where banks have an incentive to postpone payments when daylight liquidity is costly, an outcome that is socially inefficient. The latter arises in a priced credit regime where the postponement of payments can be socially efficient. Banks are risk neutral, but we show that most of the results are unaffected by risk aversion.

The Topology of the Federal Funds Market

The recent turmoil in global financial markets underscores the importance of the federal funds market as a means of distributing liquidity throughout the financial system and a tool for implementing monetary policy. In this paper, we explore the network topology of the federal funds market. We find that the network is sparse, exhibits the small-world phenomenon, and is disassortative. In addition, reciprocity loans track the federal funds rate, and centrality measures are useful predictors of the interest rate of a loan.

The Federal Home Loan Bank System: The Lender of Next-to-Last Resort?

The Federal Home Loan Bank (FHLB) System is a large, complex, and understudied government-sponsored liquidity facility that currently has more than

Technology Diffusion within Central Banking: The Case of Real-Time Gross Settlement

1 trillion in secured loans outstanding, mostly to commercial banks and thrifts. In this paper, we document the significant role played by the FHLB System at the onset of the ongoing financial crises and then provide evidence on the uses of these funds by the Systems bank and thrift members. Next, we identify the trade-offs faced by member-borrowers when choosing between accessing the FHLB System or the Federal Reserves Discount Window during the crisis period. We conclude by describing the fragmented U.S. lender-of-last-resort framework and finding that additional clarity about the respective roles of the various liquidity facilities would be helpful.

Global Trends in Large-Value Payments

We examine the diffusion of real-time gross settlement (RTGS) technology across all 174 central banks. RTGS reduces settlement risk and facilitates financial innovation in the settlement of foreign exchange trades. In 1985, only three central banks had implemented RTGS systems, and by year-end 2005, that number had increased to ninety. We find that the RTGS diffusion process is consistent with the standard S-curve prediction. Real GDP per capita, the relative price of capital, and trade patterns explain a significant part of the cross-country variation in RTGS adoption. These determinants are remarkably similar to those that seem to drive the cross-country adoption patterns of other technologies.

A search-based model of the interbank money market and monetary policy implementation

Globalization and technological innovation are two major forces affecting the financial system and its infrastructure. Perhaps nowhere are these trends more apparent than in the internationalization and automation of payments. While the effects of globalization and technological innovation are most obvious on retail payments, the influence is equally impressive on wholesale, or interbank, payments. Given the importance of payments and settlement systems to the smooth operation and resiliency of the financial system, it is important to understand the potential consequences of these developments. This article presents ten major long-range trends in the settlement of large-value payments worldwide. The trends are driven by technological innovation, structural changes in banking, and the evolution of central bank policies. The authors observe that banks, to balance risks and costs more effectively, are increasingly making large-value payments in real-time systems with advanced liquidity-management and liquidity-saving mechanisms. Moreover, banks are settling a larger number of foreign currencies directly in their home country by using offshore systems and settling a greater number of foreign exchange transactions in Continuous Linked Settlement Bank or through payment-versus-payment mechanisms in other systems. The study also shows that the service level of systems is improving, through enhancements such as longer operating hours and standardized risk management practices that adhere to common standards, while transaction fees are decreasing. Payments settled in large-value payments systems are more numerous, but on average of smaller value. Furthermore, the overall nominal total value of large-value payments is increasing, although the real value is declining.

Arbitrage, Liquidity and Exit: The Repo and Federal Funds Markets Before, During, and Emerging from the Financial Crisis

We present a search-based model of the interbank money market and monetary policy implementation. Banks are subject to reserve requirements and the central bank tenders reserves. Interbank payments redistribute holdings and banks trade with each other in a decentralized (over-the-counter) market. The central bank provides standing facilities where banks can either deposit surpluses or borrow to cover shortfalls of reserves overnight. The model provides insights on liquidity, trading volume, and rate dispersion in the interbank market – features largely absent from the canonical models in the tradition of Poole (1968) – and fits a number of stylized facts for the Eurosystem observed during the recent period of unconventional monetary policies. Moreover, it provides insights on the implications of different market structures.

Settlement Liquidity and Monetary Policy Implementation — Lessons from the Financial Crisis

This paper examines the link between the federal funds and repo markets, before, during, and emerging from the financial crisis that began in August 2007. In particular, the paper investigates the initial transmission of monetary policy to closely related money markets, pricing of risk, and liquidity effects, and then shows how these could interact if the Federal Reserve removes the substantial amount of liquidity currently in the federal funds market. The results suggest that pass-through from the federal funds rate to the repo deteriorated somewhat during the zero lower bound period, likely due to limits to arbitrage and idiosyncratic market factors. In addition, during the early part of the crisis, the pricing of federal funds, which are unsecured loans, indicated a marked jump in perceived credit risk. Moreover, the liquidity effect for the federal funds rate, or the change in the federal funds rate associated with an exogenous change in reserve balances, weakened greatly with the increase in supply of these balances over the crisis, implying a non-linear demand for federal funds. Using these analyses, the paper then shows simulations of the dynamic effects and balance sheet mechanics of liquidity draining on the federal funds and repo rates -- a tool that might be used in an exit strategy to tighten monetary policy.

Mapping Change in the Federal Funds Market

The U.S. dollar clearing and settlement system received little attention during the recent financial crisis, mainly because it performed reliably, processing record volumes and values of trades made in stressed financial markets. This article shows how Federal Reserve policy measures aimed at providing liquidity and stability to the financial system during and after the crisis had a major impact on settlement liquidity and thus on the efficiency of clearing and settlement system activity. The measures led to a substantial decrease in daylight overdrafts extended by the Federal Reserve and a quickening of settlement relative to the pre-crisis period. The decrease in daylight overdrafts reduced credit risk for the Federal Reserve and the earlier time at which payments settled suggests important efficiency gains as well as diminished operational risks. Interestingly, both improvements were the focus of the revisions to the Federal Reserve’s Payment System Risk policy, adopted in late 2008 and implemented in March 2011. To a large extent, the desired outcome had been achieved ahead of the policy change. The authors explain that as the amount of reserves available to the banking system and the opportunity cost of holding such reserves are at the center of any framework for implementing monetary policy, the recent experience offers important lessons for policy going forward.