Effects of central bank intervention on the interbank market during the sub-prime crisis

We explore whether central bank intervention improves liquidity in the interbank market during the current sub-prime crisis with unique trade and quote data from the e-MID, the only regulated electronic interbank market in the world. Central bank intervention consistently creates greater uncertainty in the interbank market. Prior to the crisis, the cover-to-bid ratio effectively conveys good and bad news from the central bank, but this link is broken during the crisis, suggesting that standard (and special) interventions that do not specifically target interbank asymmetric information fail to improve market liquidity. Our results suggest that the central bank should focus on providing interbank loan guarantees or engage in direct asset purchases rather than simply injecting capital into the system when counterparty risk poses systemic risk to the interbank market.