Inefficient liquidity creation

Stephan Luck and Paul Schempp

Journal of Financial Intermediation, 2023, vol. 53, issue C

Abstract: We present a model in which intermediaries create liquidity by issuing safe debt. Two types of intermediaries emerge: Traditional banks that create liquidity by issuing equity and holding assets to maturity, and market-based intermediaries that create liquidity by selling assets in fire sales in downturns. We show that the reliance on market-based intermediation is necessarily too high, but liquidity creation is not. It can also be too low as the endogenous fire-sale risk can push liquidity creation below its optimum. We argue that standard capital or liquidity regulation are ineffective, and optimal macroprudential regulation should instead target market-based intermediation.

Keywords: Banking; Macroprudential regulation; Liquidity creation; Fire sales; Pecuniary externalities; Shadow banking; Regulatory arbitrage (search for similar items in EconPapers)
JEL-codes: G21 G23 G28 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:53:y:2023:i:c:s1042957322000493

DOI: 10.1016/j.jfi.2022.100996

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