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Liquidity Requirements, Liquidity Choice, and Financial Stability

In: Handbook of Macroeconomics

Author

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  • Diamond, D.W.
  • Kashyap, A.K.

Abstract

We study a modification of the Diamond and Dybvig (1983) model in which the bank may hold a liquid asset, some depositors see sunspots that could lead them to run, and all depositors have incomplete information about the bank's ability to survive a run. The incomplete information means that the bank is not automatically incentivized to always hold enough liquid assets to survive runs. Regulation similar to the liquidity coverage ratio and the net stable funding ratio (that are soon be implemented) can change the bank's incentives so that runs are less likely. Optimal regulation would not mimic these rules.

Suggested Citation

  • Diamond, D.W. & Kashyap, A.K., 2016. "Liquidity Requirements, Liquidity Choice, and Financial Stability," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2263-2303, Elsevier.
    • Handle: RePEc:eee:macchp:v2-2263
    DOI: 10.1016/bs.hesmac.2016.03.011
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    More about this item

    Keywords

    Bank runs; Bank regulation; Liquidity regulation; Net stable funding ratio; Liquidity coverage ratio;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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