Banks and Market Liquidity

Stefan Arping

No 15-020/IV, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: I study a model of market-liquidity provision by levered intermediaries that, besides operating trading desks, run deposit-taking franchises. Levered intermediaries’ heightened incentive to absorb risk helps to counteract liquidity-provision frictions that, in an unlevered economy, would lead to price distortions and suppressed levels of asset origination ex ante. However, liquidity provision may also overshoot, leading to unhealthy price bubbles and causing asset origination to become excessive. Capital requirements are no panacea: They can spur risk taking and make bubbles bubblier. Ring fencing of trading activities can be, but is not necessarily, undesirable.

Keywords: Market Liquidity; Capital Requirements; Volcker Rule; Ring Fencing (search for similar items in EconPapers)
JEL-codes: G12 G14 G21 G24 (search for similar items in EconPapers)
Date: 2015-02-10
New Economics Papers: this item is included in nep-ban and nep-cfn
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20150020

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