Liquidity and Transparency in Bank Risk Management
39 Pages Posted: 14 Jun 2006 Last revised: 9 Jan 2013
Date Written: January 3, 2013
Banks may be unable to refinance short-term liabilities in case of solvency concerns. To manage this risk, banks can accumulate a buffer of liquid assets, or strengthen transparency to communicate solvency. While a liquidity buffer provides complete insurance against small shocks, transparency covers also large shocks but imperfectly. Due to leverage, an unregulated bank may choose insufficient liquidity buffers and transparency. The regulatory response is constrained: while liquidity buffers can be imposed, transparency is not verifiable. Moreover, liquidity requirements can compromise banks' transparency choices, and increase refinancing risk. To be effective, liquidity requirements should be complemented by measures that increase bank incentives to adopt transparency.
Keywords: Banks, Liquidity Risk, Regulation, Transparency, Basel III
JEL Classification: G21, G28, G32
Suggested Citation: Suggested Citation