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Banks' responses to funding liquidity shocks: lending adjustment, liquidity hoarding and fire sales

  • Leo de Haan
  • Jan Willem van den End

The crisis of 2007-2009 has shown that financial market turbulence can lead to huge funding liquidity problems for banks. This paper provides empirical evidence on banks' responses to wholesale funding shocks, using data of seventeen of the largest Dutch banks over the period January 2004 to April 2010. The dynamic interrelations among instruments of bank liquidity management are modelled in a panel Vector Autoregressive (p-VAR) framework. Orthogonalized impulse responses reveal that banks respond to a negative funding liquidity shock in a number of ways. First, banks reduce lending, especially wholesale lending. Second, banks hoard liquidity in the form of liquid bonds and central bank reserves. Third, banks conduct fire sales of securities, especially equity. We also find that fire sales are triggered by liquidity constraints rather than by solvency constraints.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 293.

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Date of creation: Apr 2011
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Handle: RePEc:dnb:dnbwpp:293
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