Banks' Liquidity Management and Financial Fragility

Luca Deidda and Ettore Panetti

No 671, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We study the interaction of banks' liquidity management and financial fragility, in an environment where banks hold a portfolio of liquidity and partially-illiquid productive assets, to insure their depositors against fundamental uncertainty, and liquidity and maturity transformation might trigger a depositors’ self-fulfilling run, modelled as a ``global game''. Under some sufficient conditions, there exists a unique recovery rate, associated with early liquidation of the productive assets, below which the banks first deplete liquidity and then liquidate, to finance depositors' withdrawals during a run. In equilibrium, the banks hoard liquidity in anticipation of a run, and narrow banking is not viable.

Date: 2018
New Economics Papers: this item is included in nep-ban
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Working Paper: Banks' Liquidity Management and Financial Fragility (2018)
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