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A Theory of Bank Liquidity Requirements

43 Pages Posted: 7 Aug 2014 Last revised: 15 Apr 2015

Charles W. Calomiris

Columbia University - Columbia Business School; National Bureau of Economic Research (NBER)

Florian Heider

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Marie Hoerova

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Date Written: April 15, 2015

Abstract

We develop a theory of bank liquidity (cash reserve) requirements. Because cash is both observable and riskless, greater cash holdings improve bank incentives to manage risk in the remaining, non-cash portfolio of risky assets. In a model with a single bank, cash is held voluntarily to stem depositors' incentives to withdraw funds early in response to adverse news. In a model with multiple banks and information externalities, deposit insurance may be optimal, and cash reserve requirements are needed to incentivize prudent behavior by banks. In a model with multiple banks subject to liquidity shocks, an interbank market can emerge as long as the group of banks imposes a cash requirement to prevent free riding on interbank liquidity assistance. Our theory has several implications for the design of liquidity regulation that are absent from existing regulatory initiatives.

Keywords: Liquidity regulation, reserve requirements, bank runs, deposit insurance, moral hazard, risk management

JEL Classification: G21, G28, E58, D82

Suggested Citation

Calomiris, Charles W. and Heider, Florian and Hoerova, Marie, A Theory of Bank Liquidity Requirements (April 15, 2015). Columbia Business School Research Paper No. 14-39. Available at SSRN: https://ssrn.com/abstract=2477101

Charles W. Calomiris

Columbia University - Columbia Business School ( email )

3022 Broadway
601 Uris, Dept. of Finance & Economics
New York, NY 10027
United States
212-854-8748 (Phone)
212-316-9219 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Florian Heider

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

HOME PAGE: http://https://sites.google.com/site/florianheider2/

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Marie Hoerova (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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