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Contingent liquidity

Sergio Nicoletti-Altimari () and Carmelo Salleo
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Sergio Nicoletti-Altimari: Banca d'Italia

No 70, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: After the crisis, bank regulators are considering mitigating liquidity risk by introducing quantity limits on liquidity and maturity mismatch. We argue that aggregate liquidity risk can be reduced with little deadweight loss by encouraging banks, through adequate regulatory relief, to satisfy part of their financing needs with a new class of securities. These would include a Roll-Over Option Facility (ROOF) that allows the issuer, for a price, to keep the funds if at maturity a readily observable variable correlated with systemic liquidity risk (e.g. the LIBOR-OIS spread) is above a trigger threshold. At roll-over the yield would reflect the current price of liquidity and credit risk, making ROOFs attractive to investors. The instrument could attenuate a liquidity crisis by reducing banks� need to roll debt over or sell off assets, and diminish the probability of runs, if markets are convinced that banks can secure sufficient liquidity when needed thanks to the widespread use of this contingent claim.

Keywords: funding; liquidity; contingent claim; financial crisis (search for similar items in EconPapers)
JEL-codes: G18 G21 G28 (search for similar items in EconPapers)
Date: 2010-09
New Economics Papers: this item is included in nep-ban and nep-reg
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