Liquidity Safety Nets for Banks

3 Journal of Corporate Law Studies 287 (2013)

Oxford Legal Studies Research Paper No. 28/2014

30 Pages Posted: 26 Oct 2013

See all articles by Paul L. Davies

Paul L. Davies

University of Oxford- Faculty of Law; European Corporate Governance Institute (ECGI)

Date Written: June 1, 2013

Abstract

Liquidity shocks are a core risk of the business model of commercial banks, which is founded on a liquidity mismatch between the banks’ liabilities and assets. A substantial part of the banks’ funding comes from short-term retail and wholesale funding, whilst a substantial part of the assets are long-term and illiquid loans. This is the source of the banks’ profits but also of their claim to fulfil an important social role. Having argued that leaving the solution to this problem to the banks alone, this article turns to examine three regulatory strategies for reducing the incidence of liquidity shocks or making banks more resilient to them. They are: regulating the level of banks’ liquidity reserves, insuring the value of the banks’ long-term assets and guaranteeing the performance of the banks’ short-term liabilities. The criteria of assessment are the least impact on the banks’ social role of transforming short-term deposits into long-term loans, coupled with the least incentive for banks to take excessive risk, the least subsidy to banking and the least cost to the public purse. It is suggested that insuring the value of the banks’ long-term assets emerges as the most attractive strategy.

Keywords: banks. liquidity, Basel III, lender of last resort, central banks, deposit guarantees

JEL Classification: E53, E58, G21, G28

Suggested Citation

Davies, Paul L., Liquidity Safety Nets for Banks (June 1, 2013). 3 Journal of Corporate Law Studies 287 (2013); Oxford Legal Studies Research Paper No. 28/2014. Available at SSRN: https://ssrn.com/abstract=2344952

Paul L. Davies (Contact Author)

University of Oxford- Faculty of Law ( email )

Harris Manchester College
Oxford, OX1 3TD
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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