Liquidity Risk and Collective Moral Hazard
48 Pages Posted: 18 Oct 2012 Last revised: 18 Feb 2017
Date Written: February 1, 2017
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: Suggested Citation