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Can banks provide liquidity in a financial crisis?

  • Nada Mora

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.

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Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

Volume (Year): (2010)
Issue (Month): Q III ()
Pages: 31-67

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Handle: RePEc:fip:fedker:y:2010:i:qiii:p:31-67:n:v.95no.3
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  1. Evan Gatev & Til Schuermann & Philip E. Strahan, 2006. "Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary with Market Conditions," NBER Working Papers 12234, National Bureau of Economic Research, Inc.
  2. Brunnermeier, Markus K & Pedersen, Lasse Heje, 2007. "Market Liquidity and Funding Liquidity," CEPR Discussion Papers 6179, C.E.P.R. Discussion Papers.
  3. Pennacchi, George, 2006. "Deposit insurance, bank regulation, and financial system risks," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 1-30, January.
  4. Todd Keister & James McAndrews, 2009. "Why are banks holding so many excess reserves?," Staff Reports 380, Federal Reserve Bank of New York.
  5. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  6. Marcin Kacperczyk & Philipp Schnabl, 2009. "When Safe Proved Risky: Commercial Paper During the Financial Crisis of 2007-2009," NBER Working Papers 15538, National Bureau of Economic Research, Inc.
  7. Tobias Adrian & Karin Kimbrough & Dina Marchioni, 2010. "The Federal Reserve's Commercial Paper Funding Facility," Staff Reports 423, Federal Reserve Bank of New York.
  8. Manju Puri & Jörg Rocholl & Sascha Steffen, 2011. "Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects," NBER Working Papers 16967, National Bureau of Economic Research, Inc.
  9. Acharya, Viral V & Schnabl, Philipp & Suarez, Gustavo, 2012. "Securitization Without Risk Transfer," CEPR Discussion Papers 8769, C.E.P.R. Discussion Papers.
  10. Judit Montoriol-Garriga & Evan Sekeris, 2009. "A question of liquidity: the great banking run of 2008?," Risk and Policy Analysis Unit Working Paper QAU09-4, Federal Reserve Bank of Boston.
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