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Liquidity coinsurance and bank capital

  • Castiglionesi, Fabio
  • Feriozzi, Fabio
  • Lóránth, Gyöngyi
  • Loriana Pelizzon

Banks can deal with their liquidity risk by holding liquid assets (self-insurance), by participating in interbank markets (coinsurance), or by using flexible financing instruments, such as bank capital (risk-sharing). We use a simple model to show that undiversi fiable liquidity risk, i.e. the liquidity risk that banks are unable to coinsure on interbank markets, represents an important risk factor affecting their capital structures. Banks facing higher undiversi fiable liquidity risk hold more capital. We posit that empirically banks that are more exposed to undiversifi able liquidity risk are less active on interbank markets. Therefore, we test for the existence of a negative relationship between bank capital and interbank market activity and find support in a large sample of U.S. commercial banks.

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Paper provided by Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt in its series SAFE Working Paper Series with number 45.

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Date of creation: 2014
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Handle: RePEc:zbw:safewp:45
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  1. Furfine, Craig, 2002. "The interbank market during a crisis," European Economic Review, Elsevier, vol. 46(4-5), pages 809-820, May.
  2. Admati, Anat R. & DeMarzo, Peter M. & Hellwig, Martin F. & Pfleiderer, Paul, 2010. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive," Research Papers 2065, Stanford University, Graduate School of Business.
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  7. 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.
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  12. Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October.
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  15. Fabio Castiglionesi, 2013. "Financial Intermediation and Liquidity," Rivista di Politica Economica, SIPI Spa, issue 1, pages 7-36, January-M.
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