Liquidity matters: Evidence from the Russian interbank market

We suggest a new transmission channel of contagion on the interbank market, namely the liquidity channel. We apply this idea to the Russian banking sector and .nd that the liquidity channel contributes signi.cantly to a better understanding and prediction of actual interbank market crises. Interbank market stability Granger causes the interbank market struc- ture, while the opposite causality is rejected. This emboldens the case for viewing the interbank market structure as endogenous. The results corroborate the thesis that prudential regulation at individual bank level is insu¢ cient to prevent systemic crises. We demonstrate that liquidity injections of a classical LOLR can e¤ectively mitigate coordination fail- ures on the interbank market not only in theory, but also in practice. In short: liquidity matters.