Too Big to Rush

Abstract

A sudden need for liquidity prompts banks to sell their assets at a discount to obtain cash. This sale disturbs the economy and slows down growth because the buyers of the assets reduce their investments in positive NPV projects. Small banks do not internalize their own impact on prices, which encourages them to start a fire sale too early. A (relatively) small probability of a liquidity shock might trigger a fire sale, causing a real crisis. Big banks internalize their own price impact, which reduces the severity of a crisis. Their sale decision is more in line with that of the social planner because they are too big to rush to sell their assets.

Keywords: Liquidity, crisis, fire sale externalities, bank competition

JEL Classification: D53, D62, E41, G01, G21