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Measuring Liquidity Mismatch in the Banking Sector

Author

Listed:
  • Arvind Krishnamurthy
  • Jennie Bai
  • Charles-Henri Weymuller

Abstract

This paper implements a liquidity measure, “Liquidity Mismatch Index (LMI),” to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities. We construct the LMIs for 2882 bank holding companies during 2002-2014 and investigate the time-series and cross-sectional patterns of banks' liquidity and liquidity risk. Aggregate banking sector liquidity worsens from +$4 trillion before the crisis to -$6 trillion in 2008, and reverses back to the pre-crisis level in 2009. We also show how a macro-prudential liquidity stress test can be conducted with the LMI metric, and that such a stress test could have revealed the fragility of the banking system in early 2007. In the cross section, we find that banks with more ex-ante liquidity mismatch have a higher stock-market crash probability and are more likely to borrow from the government during the financial crisis. Thus the LMI measure is informative regarding both individual bank liquidity risk as well as the liquidity risk of the entire banking system. We compare the LMI measure of liquidity to other measures such as Basel III's liquidity coverage ratio and net stable funding ratio, and show that LMI performs better in many dimensions. The outperformance of LMI partially results from the contract-specific time-varying liquidity sensitivity weights which are driven by market prices.

Suggested Citation

  • Arvind Krishnamurthy & Jennie Bai & Charles-Henri Weymuller, 2016. "Measuring Liquidity Mismatch in the Banking Sector," NBER Working Papers 22729, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22729
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Fricke, Christoph & Fricke, Daniel, 2017. "Vulnerable asset management? The case of mutual funds," Discussion Papers 32/2017, Deutsche Bundesbank.
    2. Mark Egan & Stefan Lewellen & Adi Sunderam, 2017. "The Cross Section of Bank Value," NBER Working Papers 23291, National Bureau of Economic Research, Inc.
    3. Hanson, Samuel G. & Shleifer, Andrei & Stein, Jeremy C. & Vishny, Robert W., 2015. "Banks as patient fixed-income investors," Journal of Financial Economics, Elsevier, vol. 117(3), pages 449-469.
    4. repec:uts:finphd:1-2018 is not listed on IDEAS
    5. Stefan Lewellen & Adi Sunderam & Mark Egan, 2017. "The Cross Section of Bank Value," 2017 Meeting Papers 1283, Society for Economic Dynamics.
    6. Zhou, Zhongzheng, 2019. "Liquidity Backup from Commercial Banks to Shadow Banks," MPRA Paper 94713, University Library of Munich, Germany.
    7. Legroux, Vincent & Rahmouni-Rousseau, Imène & Szczerbowicz, Urszula & Valla, Natacha, 2017. "Stabilising virtues of central banks: (re)matching bank liquidity," EIB Working Papers 2017/01, European Investment Bank (EIB).
    8. Roberts, Daniel & Sarkar, Asani & Shachar, Or, 2018. "Bank Liquidity Creation, Systemic Risk, and Basel Liquidity Regulations," Staff Reports 852, Federal Reserve Bank of New York, revised 01 Aug 2019.
    9. Alan Moreira & Alexi Savov, 2014. "The Macroeconomics of Shadow Banking," NBER Working Papers 20335, National Bureau of Economic Research, Inc.
    10. repec:gam:jrisks:v:7:y:2019:i:2:p:46-:d:226193 is not listed on IDEAS
    11. Lu, Ruoxi & Bessler, David A. & Leatham, David J., 2018. "The transmission of liquidity shocks via China's segmented money market: Evidence from recent market events," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 57(C), pages 110-126.
    12. Fricke, Christoph & Fricke, Daniel, 2017. "Vulnerable Funds?," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168209, Verein für Socialpolitik / German Economic Association.
    13. Robert McKeown, 2017. "How Vulnerable Is The Canadian Banking System To Fire-sales?," Working Paper 1381, Economics Department, Queen's University.
    14. Itamar Drechsler & Alexi Savov & Philipp Schnabl, 2018. "Banking on Deposits: Maturity Transformation without Interest Rate Risk," NBER Working Papers 24582, National Bureau of Economic Research, Inc.
    15. repec:sgm:pzwzuw:v:15:i:66:y:2017:p:53-63 is not listed on IDEAS
    16. Wang, J. Christina, 2017. "Banks' search for yield in the low interest rate environment: a tale of regulatory adaptation," Working Papers 17-3, Federal Reserve Bank of Boston.
    17. Agarwal, Vikas & Aragon, George O. & Shi, Zhen, 2015. "Funding liquidity risk of funds of hedge funds: Evidence from their holdings," CFR Working Papers 15-12, University of Cologne, Centre for Financial Research (CFR).

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • 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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