49 Pages Posted: 11 Jan 2016 Last revised: 5 Sep 2019
Date Written: September 5, 2019
We provide a theoretical model for funding liquidity that extends the literature by allowing financial institutions to raise short-term unsecured funding in addition to secured funding. We identify a new liquidity spiral, a credit limit spiral, for unsecured funding and show how it reinforces the margin and loss spiral for secured funding. Our model brings to light a dual role of margins. While higher margins reduce secured funding, they relax the funding constraint in the unsecured market ceteris paribus. We show that there is commonality and substitution effects in funding illiquidity, and discuss how central bank and regulatory policies can prevent illiquidity.
Keywords: funding liquidity, unsecured and secured funding, liquidity spirals, monetary policy, regulation
JEL Classification: E43, E58, G01, G12, G18, G21, G28
Suggested Citation: Suggested Citation