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Liquidity management, fire sale and liquidity crises in banking: the role of leverage

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  • Gomez, Fabiana

    (University of Bristol)

  • Vo, Quynh-Anh

    (Bank of England)

Abstract

This paper proposes a positive theory of the link between banks’ capitalisation and their liquidity-risk taking as well as the severity of fire-sale problems and liquidity crises. In the basic framework of an individual bank’s decisions, we find that banks’ incentives to hold liquidity for precautionary reason are increasing with their capital. In a continuum-of-banks setting in which both precautionary and speculative motives of liquidity holdings are taken into account, we find that while the fire-sale discount is decreasing with the capitalisation of the banking system, the link between the latter and the severity of liquidity crises is not monotonic.

Suggested Citation

  • Gomez, Fabiana & Vo, Quynh-Anh, 2020. "Liquidity management, fire sale and liquidity crises in banking: the role of leverage," Bank of England working papers 894, Bank of England.
    • Handle: RePEc:boe:boeewp:0894
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    References listed on IDEAS

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    Cited by:

    1. Dietrich, Diemo & Gehrig, Thomas, 2021. "Speculative and precautionary demand for liquidity in competitive banking markets," LSE Research Online Documents on Economics 118869, London School of Economics and Political Science, LSE Library.
    2. Vo, Quynh-Anh, 2021. "Interactions of capital and liquidity requirements: a review of the literature," Bank of England working papers 916, Bank of England.

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    More about this item

    Keywords

    Leverage; Precautionary liquidity holdings; speculative liquidity holdings; wholesale debts; cash-In-the-market pricing;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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