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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.

Suggested Citation

  • Nada Mora, 2010. "Can banks provide liquidity in a financial crisis?," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 31-67.
  • Handle: RePEc:fip:fedker:y:2010:i:qiii:p:31-67:n:v.95no.3
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    References listed on IDEAS

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    1. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
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    7. Pennacchi, George, 2006. "Deposit insurance, bank regulation, and financial system risks," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 1-30, January.
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    Cited by:

    1. Cheng & Fung & Hu & Cheng, 2015. "Interest rate deregulation and banks' off-balance-sheet activities: a Hong Kong perspective," Applied Economics, Taylor & Francis Journals, vol. 47(47), pages 5088-5102, October.
    2. Acharya, Viral V & Mora, Nada, 2011. "Are Banks Passive Liquidity Backstops? Deposit Rates and Flows during the 2007-2009 Crisis," CEPR Discussion Papers 8706, C.E.P.R. Discussion Papers.
    3. Zlatuse Komarkova & Adam Gersl & Lubos Komarek, 2011. "Models for Stress Testing Czech Banks' Liquidity Risk," Working Papers 2011/11, Czech National Bank, Research Department.
    4. 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.
    5. 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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