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Liquidity Coinsurance and Bank Capital

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  • Castiglionesi, Fabio
  • Feriozzi, Fabio
  • Lóránth, Gyöngyi
  • Pelizzon, Loriana

Abstract

Banks can deal with their liquidity risk by holding liquid assets (self-insurance), by participating in the interbank market (coinsurance), or by using flexible financing instruments, such as bank capital (risk-sharing). We study how the access to an interbank market affects banks' incentive to hold capital. A general insight is that from a risk-sharing perspective it is optimal to postpone payouts to capital investors when a bank is hit by a liquidity shock that it cannot coinsure on the interbank market. This mechanism produces a negative relationship between interbank activity and bank capital. We provide empirical support for this prediction in a large sample of U.S. commercial banks, as well as in a sample of European and Japanese commercial banks.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9162.

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Date of creation: Oct 2012
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Handle: RePEc:cpr:ceprdp:9162

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Keywords: Bank Capital; Interbank Markets; Liquidity Coinsurance.;

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  1. Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October.
  2. Gara Afonso & Anna Kovner & Antoinette Schoar, 2010. "Stressed, not frozen: the Federal Funds market in the financial crisis," Staff Reports 437, Federal Reserve Bank of New York.
  3. Furfine, Craig, 2002. "The interbank market during a crisis," European Economic Review, Elsevier, vol. 46(4-5), pages 809-820, May.
  4. Douglas W. Diamond & Raghuram G. Rajan, . "A Theory of Bank Capital," CRSP working papers 363, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  9. Cocco, João F. & Gomes, Francisco J. & Martins, Nuno C., 2009. "Lending relationships in the interbank market," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 24-48, January.
  10. Mark J. Flannery & Kasturi P. Rangan, 2008. "What Caused the Bank Capital Build-up of the 1990s?," Review of Finance, European Finance Association, vol. 12(2), pages 391-429.
  11. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  12. Besanko, David & Kanatas, George, 1996. "The Regulation of Bank Capital: Do Capital Standards Promote Bank Safety?," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 160-183, April.
  13. Allen Berger & Robert DeYoung & Mark Flannery & David Lee & Ozde Oztekin, 2008. "How do large banking organizations manage their capital ratio?," Research Working Paper RWP 08-01, Federal Reserve Bank of Kansas City.
  14. Furlong, Frederick T. & Keeley, Michael C., 1989. "Capital regulation and bank risk-taking: A note," Journal of Banking & Finance, Elsevier, vol. 13(6), pages 883-891, December.
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