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Liquidity policies and financial fragility

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  • Lopomo Beteto Wegner, Danilo

Abstract

This paper proposes a model of endogenous formation of financial networks whereby government and central bank policies that aim at enhancing market liquidity play a key role. Under these policies, large and less liquid investments become more profitable, however to finance them banks need to resort to the interbank market. This makes the structure of the financial network - and its associated exposure to shocks, i.e., fragility - dependent on liquidity policies chosen by the government and central bank. It is shown that policies that enhance liquidity can increase the capitalization of the banking system and, concomitantly, make it more fragile.

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  • Lopomo Beteto Wegner, Danilo, 2020. "Liquidity policies and financial fragility," International Review of Economics & Finance, Elsevier, vol. 70(C), pages 135-153.
    • Handle: RePEc:eee:reveco:v:70:y:2020:i:c:p:135-153
    DOI: 10.1016/j.iref.2020.06.008
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    Cited by:

    1. Cristina Zeldea, 2020. "Modeling the Connection between Bank Systemic Risk and Balance-Sheet Liquidity Proxies through Random Forest Regressions," Administrative Sciences, MDPI, vol. 10(3), pages 1-14, August.

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    More about this item

    Keywords

    Financial networks; Market liquidity; Financial fragility;
    All these keywords.

    JEL classification:

    • 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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