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Banks’ Liquidity Management and Systemic Risk

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  • Ettore Panetti
  • Luca G. Deidda

Abstract

We study a novel mechanism to explain the interaction between banks’ liquidity management and the emergence of systemic financial crises, in the form of self-fulfilling runs. To this end, we develop an environment where banks offer insurance to their depositors against both idiosyncratic and aggregate real shocks, by holding a portfolio of liquidity and productive but illiquid assets. Moreover, banks’ asset portfolios and the probability of a depositors’ self-fulfilling run are jointly determined via a “global game”. We characterize the sufficient conditions under which there exists a unique threshold recovery rate, associated with the early liquidation of the productive assets, below which the banks first employ liquidity and then liquidate, in order to finance depositors’ early withdrawals. Ex ante, the banks hold more liquidity than in a full-information economy, where there are no self-fulfilling runs and risk is only due to idiosyncratic and aggregate real shocks.

Suggested Citation

  • Ettore Panetti & Luca G. Deidda, 2017. "Banks’ Liquidity Management and Systemic Risk," Working Papers w201713, Banco de Portugal, Economics and Research Department.
    • Handle: RePEc:ptu:wpaper:w201713
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    References listed on IDEAS

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    Cited by:

    1. Leonello, Agnese & Mendicino, Caterina & Panetti, Ettore & Porcellacchia, Davide, 2022. "Savings, efficiency and bank runs," Working Paper Series 2636, European Central Bank.

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