Scope and limits of bank liquidity creation

Diemo Dietrich and Thomas Gehrig

Journal of Financial Intermediation, 2025, vol. 61, issue C

Abstract: In standard banking models a demand for liquidity arises because investors want to take precautions against sudden consumption needs. It has long been taken for granted that banks’ maturity transformation is because they insure against such risk, exposing them to crises and justifying bank regulation. We show that if a demand for liquidity arises additionally for another important reason, their co-existence substantially alters equilibrium outcomes. Specifically, we introduce investors who want to preserve flexibility in case better investment opportunities arrive later. We show that (1) there is no maturity transformation if the funding liquidity of new investment opportunities is not sufficiently limited, (2) equilibria in models that consider only a single reason for liquidity demand are not necessarily robust, (3) an equilibrium in pure strategies in the depositing game may not exist at all.

Keywords: Investment opportunities; Consumption needs; Liquidity demand; Competitive insurance markets (search for similar items in EconPapers)
JEL-codes: D11 D86 E21 E22 G21 L22 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:61:y:2025:i:c:s1042957324000512

DOI: 10.1016/j.jfi.2024.101123

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