Banks’ Liquidity Management and Systemic Risk

Ettore Panetti and Luca Deidda

Working Papers from Banco de Portugal, Economics and Research Department

Abstract: We study a novel mechanism to explain the interaction between banks’ liquidity management and the emergence of systemic financial crises, in the form of self-fulfilling runs. To this end, we develop an environment where banks offer insurance to their depositors against both idiosyncratic and aggregate real shocks, by holding a portfolio of liquidity and productive but illiquid assets. Moreover, banks’ asset portfolios and the probability of a depositors’ self-fulfilling run are jointly determined via a “global game”. We characterize the sufficient conditions under which there exists a unique threshold recovery rate, associated with the early liquidation of the productive assets, below which the banks first employ liquidity and then liquidate, in order to finance depositors’ early withdrawals. Ex ante, the banks hold more liquidity than in a full-information economy, where there are no self-fulfilling runs and risk is only due to idiosyncratic and aggregate real shocks.

JEL-codes: G01 G21 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Banks' Liquidity Management and Systemic Risk (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:ptu:wpaper:w201713

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