AbstractAfter 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 banksâ€™ 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.
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Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Questioni di Economia e Finanza (Occasional Papers) with number 70.
Date of creation: Sep 2010
Date of revision:
funding; liquidity; contingent claim; financial crisis;
Find related papers by JEL classification:
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
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