European banks' funding realignment during the European debt crisis: impact of counterparty risk and funding liquidity on FX swap pricing

Yoshiko Suzuki ()
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Yoshiko Suzuki: Keio University Graduate School of Economics

Economics Bulletin, 2016, vol. 36, issue 2, 696-703

Abstract: This study examines European banks' dollar procurement from U.S. money market funds (MMFs) through a sampled period (2010–2013) of the European debt crisis. It investigates whether banks in specific countries exerted stronger influence on foreign exchange swap pricing during distinct periods of the crisis, taking into consideration not only counterparty risk but also low funding liquidity. The factors contributing to the deviations in covered interest parity in foreign exchange swaps are also analyzed during four stages of the crisis. The empirical studies conducted indicate that counterparty risk of French banks raised the European premium at the peak of the crisis and during the period following outright monetary transactions. On the other hand, counterparty risk of German banks increased the European premium early in the crisis and after long-term refinancing operations (LTRO). The rise in premium became distinctly associated with funding stress due to banks' dependency on MMFs. LTRO generally alleviated stress for major European banks, but it did not compensate for counterparty risk at individual banks. The findings suggest that excess reserves held by banks in the euro area did not assure ample funding liquidity or offset counterparty risk. This excess reserve was amassed to hoard liquidity; however, liquidity available for funding diminished and served to widen the European premium.

Keywords: FX swaps; covered interest parity; money market funds; European crisis (search for similar items in EconPapers)
JEL-codes: E4 F3 (search for similar items in EconPapers)
Date: 2016-04-14
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Citations: View citations in EconPapers (1)

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