Liquidity Risk and Collective Moral Hazard

48 Pages Posted: 18 Oct 2012 Last revised: 18 Feb 2017

See all articles by Diana Bonfim

Diana Bonfim

Banco de Portugal; Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics

Moshe Kim

University of Haifa

Date Written: February 1, 2017

Abstract

Banks individually optimize their liquidity risk management, often neglecting the externalities generated by their choices on the overall risk of the financial system. This is the main argument to support the regulation of liquidity risk. However, banks may have incentives to optimize their choices not strictly at the individual level, but engaging instead in collective risk-taking strategies, which may intensify systemic risk. In this paper we look for evidence of such collective behaviors, with an emphasis on the period preceding the global financial crisis. We find strong and robust evidence of peer effects in banks' liquidity risk management. This result suggests that incentives for collective risk taking behaviors may play a role in banks' choices, thus calling for a macroprudential approach to liquidity risk regulation.

Keywords: banks, liquidity risk, regulation, herding, peer effects, Basel III, macroprudential policy, systemic risk

JEL Classification: G21, G28

Suggested Citation

Bonfim, Diana and Kim, Moshe, Liquidity Risk and Collective Moral Hazard (February 1, 2017). European Banking Center Discussion Paper No. 2012-024. Available at SSRN: https://ssrn.com/abstract=2163547 or http://dx.doi.org/10.2139/ssrn.2163547

Diana Bonfim (Contact Author)

Banco de Portugal ( email )

Av Almirante Reis, 71
P-1150-012 Lisboa
Portugal

Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics ( email )

Palma de Cima
Lisbon, 1649-023
Portugal

Moshe Kim

University of Haifa ( email )

Mount Carmel
Haifa, 31905
Israel

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