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Banks' Liquidity Management and Financial Fragility

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  • Luca Deidda

    (Università di Sassari)

  • Ettore Panetti

    (Banco de Portugal)

Abstract

We study the interaction of banks' liquidity management and financial fragility, in an environment where banks hold a portfolio of liquidity and partially-illiquid productive assets, to insure their depositors against fundamental uncertainty, and liquidity and maturity transformation might trigger a depositors’ self-fulfilling run, modelled as a ``global game''. Under some sufficient conditions, there exists a unique recovery rate, associated with early liquidation of the productive assets, below which the banks first deplete liquidity and then liquidate, to finance depositors' withdrawals during a run. In equilibrium, the banks hoard liquidity in anticipation of a run, and narrow banking is not viable.

Suggested Citation

  • Luca Deidda & Ettore Panetti, 2018. "Banks' Liquidity Management and Financial Fragility," 2018 Meeting Papers 671, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:671
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    References listed on IDEAS

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