Liquidity policies and financial fragility

Danilo Lopomo Beteto Wegner

International Review of Economics & Finance, 2020, vol. 70, issue C, 135-153

Abstract: This paper proposes a model of endogenous formation of financial networks whereby government and central bank policies that aim at enhancing market liquidity play a key role. Under these policies, large and less liquid investments become more profitable, however to finance them banks need to resort to the interbank market. This makes the structure of the financial network - and its associated exposure to shocks, i.e., fragility - dependent on liquidity policies chosen by the government and central bank. It is shown that policies that enhance liquidity can increase the capitalization of the banking system and, concomitantly, make it more fragile.

Keywords: Financial networks; Market liquidity; Financial fragility (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:70:y:2020:i:c:p:135-153

DOI: 10.1016/j.iref.2020.06.008

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