Strategic Liquidity Mismatch and Financial Sector Stability
62 Pages Posted: 22 Nov 2015 Last revised: 14 Jan 2019
Date Written: January 2019
This paper examines whether banks strategically incorporate their competitors’ liquidity mismatch policies when determining their own and how these collective decisions impact financial sector stability. Using a novel identification strategy exploiting the presence of partially overlapping peer groups, I show that banks’ liquidity transformation activity is driven by that of their peers. These correlated decisions are concentrated on the asset side of riskier banks and are asymmetric, with mimicking occurring only when competitors are taking more risk. Accordingly, this strategic behavior increases banks’ default risk and overall systemic risk, highlighting the importance of regulating liquidity risk from a macroprudential perspective.
JEL Classification: G01, G20, G21, G28
Suggested Citation: Suggested Citation