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Can banks provide liquidity in a financial crisis?

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  • Nada Mora

Abstract

In financial crises of the recent past, investors often withdrew from securities markets and placed their funds into safer assets, such as U.S. Treasuries and bank deposits. During such episodes, a wide range of businesses shut out of securities markets sought to fund their operations by drawing down credit lines established with banks during normal times. Awash with funds from depositors seeking a safe haven, banks had no difficulty meeting these increased credit demands. Thus, banks helped avoid financial disruptions and business liquidations that would have occurred in the absence of a liquidity backstop. ; In 2007-09, however, banks were at the center of the financial crisis. While significant risks were present in some other financial institutions, this crisis was special in that commercial banks were much more exposed to losses than in recent past crises. This key feature of the crisis casts doubt on the notion that banks are a natural source of liquidity during financial crises. Were bank deposits still viewed as a safe haven, and if not, how compromised was their ability to meet the demand for liquidity? ; Mora examines how commercial bank deposits and lending evolved during the recent crisis compared with past episodes of financial stress. She concludes that the bank-centered nature of the crisis made it harder than in the past for banks to attract deposits and provide liquidity to borrowers shut out of securities markets.

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Bibliographic Info

Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

Volume (Year): (2010)
Issue (Month): Q III ()
Pages: 31-67

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Handle: RePEc:fip:fedker:y:2010:i:qiii:p:31-67:n:v.95no.3

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  1. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
  2. Puri, Manju & Rocholl, Jörg & Steffen, Sascha, 2011. "Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects," Journal of Financial Economics, Elsevier, vol. 100(3), pages 556-578, June.
  3. Pennacchi, George, 2006. "Deposit insurance, bank regulation, and financial system risks," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 1-30, January.
  4. Tobias Adrian & Karin Kimbrough & Dina Marchioni, 2011. "The Federal Reserve’s Commercial Paper Funding Facility," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 25-39.
  5. Todd Keister & James McAndrews, 2009. "Why are banks holding so many excess reserves?," Staff Reports 380, Federal Reserve Bank of New York.
  6. Evan Gatev & Til Schuermann & Philip E. Strahan, 2009. "Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary with Market Conditions," Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 995-1020, March.
  7. Acharya, Viral V. & Schnabl, Philipp & Suarez, Gustavo, 2013. "Securitization without risk transfer," Journal of Financial Economics, Elsevier, vol. 107(3), pages 515-536.
  8. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  9. Judit Montoriol-Garriga & Evan Sekeris, 2009. "A question of liquidity: the great banking run of 2008?," Risk and Policy Analysis Unit Working Paper QAU09-4, Federal Reserve Bank of Boston.
  10. Marcin Kacperczyk & Philipp Schnabl, 2009. "When Safe Proved Risky: Commercial Paper During the Financial Crisis of 2007-2009," NBER Working Papers 15538, National Bureau of Economic Research, Inc.
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Cited by:
  1. Zlatuse Komarkova & Adam Gersl & Lubos Komarek, 2011. "Models for Stress Testing Czech Banks' Liquidity Risk," Working Papers 2011/11, Czech National Bank, Research Department.
  2. Viral V. Acharya & Nada Mora, 2011. "Are banks passive liquidity backstops? deposit rates and flows during the 2007-2009 crisis," Research Working Paper RWP 11-06, Federal Reserve Bank of Kansas City.
  3. Alice O. Nakamura & Leonard I. Nakamura & Masao Nakamura, 2012. "Building the Innovation Union: Lessons from the 2008 Financial Crisis," Working Papers 12-17, Federal Reserve Bank of Philadelphia.
  4. Miguel Ramirez & Aalok Pandey, 2012. "Why does the Cost of Credit Intermediation Increase for Small Firms Relative to Large Firms during Recessions? A Conceptual and Empirical Analysis," Working Papers 1205, Trinity College, Department of Economics.

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