Liquidity Risk, Cash-Flow Constraints and Systemic Feedbacks

42 Pages Posted: 26 Jun 2012

See all articles by Sujit Kapadia

Sujit Kapadia

European Central Bank (ECB); Bank of England

Mathias Drehmann

Bank for International Settlements (BIS)

John Elliott

Bank of England - Monetary Analysis

Gabriel Sterne

Bank of England

Date Written: June 21, 2012

Abstract

The endogenous evolution of liquidity risk is a key driver of financial crises. This paper models liquidity feedbacks in a quantitative model of systemic risk. The model incorporates a number of channels important in the current financial crisis. As banks lose access to longer-term funding markets, their liabilities become increasingly short term, further undermining confidence. Stressed banks’ defensive actions include liquidity hoarding and asset fire sales. This behaviour can trigger funding problems at other banks and may ultimately cause them to fail. In presenting results, we analyse scenarios in which these channels of contagion operate, and conduct illustrative simulations to show how liquidity feedbacks may markedly amplify distress.

Keywords: Systemic risk, funding liquidity risk, contagion, stress testing

JEL Classification: G01, G21, G32

Suggested Citation

Kapadia, Sujit and Drehmann, Mathias and Elliott, John and Sterne, Gabriel, Liquidity Risk, Cash-Flow Constraints and Systemic Feedbacks (June 21, 2012). Bank of England Working Paper No. 456. Available at SSRN: https://ssrn.com/abstract=2093439 or http://dx.doi.org/10.2139/ssrn.2093439

Sujit Kapadia (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
020-7601-5507 (Phone)

Mathias Drehmann

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

John Elliott

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Gabriel Sterne

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
105
Abstract Views
523
rank
255,167
PlumX Metrics