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How do Banks Manage Liquidity Risk? Evidence from Equity and Deposit Markets in the Fall of 1998

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  • Philip E. Strahan
  • Evan Gatev
  • Til Schuermann

Abstract

We report evidence from the equity market that unused loan commitments expose banks to systematic liquidity risk, especially during crises such as the one observed in the fall of 1998. We also find, however, that banks with higher levels of transactions deposits had lower risk during the 1998 crisis than other banks. These banks experienced large inflows of funds just as they were needed -- when liquidity demanded by firms taking down funds from commercial paper backup lines of credit peaked. Our evidence suggests that combining loan commitments with deposits mitigates liquidity risk, and that this deposit-lending synergy is especially powerful during period of crises as nervous investors move funds into their banks.

Suggested Citation

  • Philip E. Strahan & Evan Gatev & Til Schuermann, 2004. "How do Banks Manage Liquidity Risk? Evidence from Equity and Deposit Markets in the Fall of 1998," NBER Working Papers 10982, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10982
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    References listed on IDEAS

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    1. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    2. Stewart C. Myers & Raghuram G. Rajan, 1998. "The Paradox of Liquidity," The Quarterly Journal of Economics, Oxford University Press, vol. 113(3), pages 733-771.
    3. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    4. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 2002. "Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit-Taking," Journal of Finance, American Finance Association, vol. 57(1), pages 33-73, February.
    5. John H. Boyd & Mark Gertler, 1994. "Are banks dead? Or are the reports greatly exaggerated?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-23.
    6. Franklin R. Edward, 1999. "Hedge Funds and the Collapse of Long-Term Capital Management," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 189-210, Spring.
    7. Dong Lee & Bong-Chan Kho & Rene M. Stulz, 2000. "U.S. Banks, Crises, and Bailouts: From Mexico to LTCM," American Economic Review, American Economic Association, vol. 90(2), pages 28-31, May.
    8. Marc R. Saidenberg & Philip E. Strahan, 1999. "Are banks still important for financing large businesses?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 5(Jul).
    9. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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    Cited by:

    1. Ramon Moreno, 2006. "The changing nature of risks facing banks," BIS Papers chapters,in: Bank for International Settlements (ed.), The banking system in emerging economies: how much progress has been made?, volume 28, pages 67-98 Bank for International Settlements.
    2. Adam Ashcraft & Morten L. Bech & W. Scott Frame, 2010. "The Federal Home Loan Bank System: The Lender of Next-to-Last Resort?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(4), pages 551-583, June.
    3. Ratnovski, Lev, 2013. "Liquidity and transparency in bank risk management," Journal of Financial Intermediation, Elsevier, vol. 22(3), pages 422-439.

    More about this item

    JEL classification:

    • 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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