Interbank Market and Rollover Risk: from Monetary Theories to an Agent-Based Stock-Flow Consistent simulation

This dissertation, in its three essays, investigates the role played by the risk of rollover with respect to banks’ funding decisions and potential interbank market tensions. Since the recent financial crisis, researchers have increasingly acknowledged the relevance of interbank market liquidity frictions in undermining financial stability, weakening monetary policy transmission mechanism and central bankers’ ability to stimulate credit expansion and the real economy. In an attempt to find plausible explanations of the recent economic downturn, banks inability or unwillingness to rollover short-run debt among each other has gathered greater attention. For this purpose, the present dissertation i) explores the issue of the rollover-channel within monetary theories and in the most recent economic literature about refinancing risk and interbank market freeze, ii) proposes a Stock-Flow Consistent (SFC) dynamic model which accounts for banks’ debt maturity structure decisions and interbank relations, and iii) provides an extension of the model in (ii) to an Agent-Based Stock-Flow Consistent (AB-SFC) framework. The aim of the 1st chapter is two-fold: i) to contextualize potential vulnerability in banks’ refinancing practises within modern heterodox monetary theories, and ii) to provide a broader picture of the role played by the risk of rollover in deteriorating bank-to-bank relations. From the analysis of the existing literature, this work draws two main conclusions. First, rising interest rates and credit-supply shrinking should not be expected only in case of central banks’ non-accommodative behaviours. Second, the rollover-channel should be interpreted as a ‘rollover-circuit’ that intensifies two vicious cycles. On the one hand, increasing rollover risk leading to higher maturity mismatch (first cycle) impacts the value of collaterals and forces banks to sell assets at fire-sale prices. On the other hand, this mechanism induces a double causality between low market liquidity and low funding liquidity (second cycle), making banks more reluctant to lend to each other, and funds more difficult to be rolled over. In turn, banks become more dependent on overnight funding with daily refinancing frequencies, further intensifying the first cycle, which might be harmful for the desirable balance between discipline and elasticity. In line with this, the 2nd chapter extends the current SFC framework to interbank relations in the attempt to capture both potential intra-sectoral flows, so far neglected in this methodological structure, and the second causal link of endogenous monetary theory, from changes in deposits to changes in reserves. For this purpose, the model consists of a more complex banking system which includes banks’ funding choices and reserve management strategies, with the aim of analyzing the impact of funding liquidity risk, considered as a proxy for the risk of rollover, on the performances of the postulated interbank market. Starting from the functioning of a payment system within an overdraft economy, two banks can interact in two segments of the unsecured interbank market: the overnight and the term one. The main feature of this model is the introduction of a measure for maturity mismatch and funding liquidity risk according to which the borrowing bank can choose the demanded duration of interbank loans. The central bank is modelled in both its accommodating and disciplinary roles, in case interbank lending comes to a standstill. The main results of the simulations are: i) interbank volumes seem to be highly dependent on the maturity composition of the two banks’ balance sheets; ii) as the stress perceived in the interbank market increases, banks’ maturity preferences lead the interbank market rates spread to its highest possible levels; iii) the constant excessive maturity mismatch leads the volumes of the overnight segment to be lower with respect to the term one, suggesting the importance of studying the interactions of the two segments when accounting for funding liquidity risk. The 3rd and final chapter analyzes the functioning of modern payment systems through the lens of banks’ maturity mismatch practises proposing an Agent-Based Stock-Flow Consistent model. Again, banks can interact in two segments of the interbank market diversified by maturity, overnight and term. Their funding sources are chosen according to a Margin of Stability constructed on the basis of the residual duration of their assets and liabilities, following the Net Stable Funding Ratio introduced by Basel III. From the simulations of the model, the following results emerge: (i) the postulated economy is resilient to the potential frictions arising from payment liquidity shocks; (ii) when banks decide their funding sources with the objective of limiting their degree of maturity transformation and risk of rollover the economic system appears more stable; (iii) the impact of banks’ margins of stability on the maturity composition of their assets and liabilities is pro-cyclical, and leads to an inverted process of maturity mismatch where short-term investments are funded by long-term sources; (iv) when maturity mismatch is very low, as resulting from the simulations of this analysis, increasing tensions on the market do not impact banks’ preferences for maturities and the overall stability of the economy