Strategic Liquidity Mismatch and Financial Sector Stability
64 Pages Posted: 22 Nov 2015 Last revised: 27 Sep 2017
Date Written: September 1, 2017
This paper examines the impact of banks' collective liquidity mismatch policies on the stability of the financial sector. Using a novel identification strategy exploiting partially overlapping peer groups, I show that the liquidity created by individual banks is in large part driven by the liquidity transformation activity of their respective peers. Such correlated liquidity mismatch decisions are asymmetric and concentrated on the asset-side component of liquidity creation. Importantly, this strategic behavior increases both the default risk of individual institutions and overall systemic risk. From a macroprudential perspective, the results highlight the importance of explicitly regulating systemic liquidity risk.
Keywords: Liquidity mismatch, financial stability, liquidity creation, systemic risk
JEL Classification: G01, G20, G21, G28
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