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Endogenous exposure to systemic liquidity risk

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Listed:
  • Cao, Jin
  • Illing, Gerhard

Abstract

Traditionally, aggregate liquidity shocks are modeled as exogenous events. This paper analyzes the adequate policy response to endogenous exposure to systemic liquidity risk. We analyze the feedback between lender-of-last-resort policy and incentives of private banks, determining the aggregate amount of liquidity available. We show that imposing minimum liquidity standards for banks ex ante is a crucial requirement for sensible lender-of-last-resort policy. In addition, we analyze the impact of equity requirements and narrow banking, in the sense that banks are required to hold sufficient liquid funds so as to pay out in all contingencies. We show that both policies are strictly inferior to imposing minimum liquidity standards ex ante combined with lender-of-last-resort policy.

Suggested Citation

  • Cao, Jin & Illing, Gerhard, 2011. "Endogenous exposure to systemic liquidity risk," Munich Reprints in Economics 19998, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenar:19998
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    Cited by:

    1. Mark Carlson, 2015. "Lessons from the Historical Use of Reserve Requirements in the United States to Promote Bank Liquidity," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 191-224, January.
    2. Gerardo Ferrara & Sam Langfield & Zijun Liu & Tomohiro Ota, 2019. "Systemic illiquidity in the interbank network," Quantitative Finance, Taylor & Francis Journals, vol. 19(11), pages 1779-1795, November.
    3. Jin Cao & Gerhard Illing, 2022. "Money in the Equilibrium of Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(1), pages 119-144, February.
    4. Allen, Franklin & Carletti, Elena & Gale, Douglas, 2014. "Money, financial stability and efficiency," Journal of Economic Theory, Elsevier, vol. 149(C), pages 100-127.
    5. Diana Bonfim & Moshe Kim, 2012. "Systemic Liquidity Risk," Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies, Banco de Portugal, Economics and Research Department.
    6. Khemais Zaghdoudi & Abdelaziz Hakimi, 2017. "The Determinants of Liquidity Risk: Evidence from Tunisian Banks," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 7(2), pages 1-5.
    7. Aleksandra Maslowska-Jokinen & Anna MatysekJedrych, 2016. "Post-Crisis Regulatory and Supervisory Arrangements – The New ‘Old’ Central Banking," BAFFI CAREFIN Working Papers 1632, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    8. Bonfim, D. & Kim, M., 2012. "Liquidity Risk in Banking : Is there Herding?," Other publications TiSEM 6e6df5ea-401b-49a2-b1be-4, Tilburg University, School of Economics and Management.
    9. Douglas Gale, 2015. "Regulation and Sausages," Manchester School, University of Manchester, vol. 83, pages 1-26, December.

    More about this item

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • 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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