Banking on the Edge: Liquidity Constraints and Illiquid Asset Risk

Joshua Bosshardt, Ali Kakhbod and Farzad Saidi

No 17811, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We examine how banks' liquidity requirements affect their incentives to take risk with their remaining illiquid assets. Our model predicts that banks with more stable liabilities are more likely to increase risk taking in response to tighter liquidity requirements. This prediction is borne out in transaction-level data on corporate and mortgage loans for U.S. banks subject to the liquidity coverage ratio (LCR). For identification, we exploit variation in long-term bank bonds held by insurance companies that are not affected by the LCR. Our results highlight a trade-off between bank risk taking and simultaneously curbing short-term and long-term liquidity-risk exposures.

Keywords: bank risk taking; insurance sector; LCR (search for similar items in EconPapers)
JEL-codes: G20 G21 G22 G28 (search for similar items in EconPapers)
Date: 2023-01
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