Strategic Liquidity Mismatch and Financial Sector Stability

62 Pages Posted: 22 Nov 2015 Last revised: 14 Jan 2019

Date Written: January 2019

Abstract

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

Silva, André F., Strategic Liquidity Mismatch and Financial Sector Stability (January 2019). Available at SSRN: https://ssrn.com/abstract=2693732 or http://dx.doi.org/10.2139/ssrn.2693732

André F. Silva (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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