Liquidity Rules and Credit Booms

132 Pages Posted: 20 Jan 2016 Last revised: 15 Apr 2023

See all articles by Kinda Hachem

Kinda Hachem

University of Chicago - Booth School of Business

Zheng Michael Song

University of Chicago

Date Written: January 2016

Abstract

This paper shows that liquidity regulation can trigger unintended credit booms in the presence of interbank market power. We consider a price-setter and a continuum of price-takers who trade reserves after the realization of idiosyncratic liquidity shocks. The price-takers are endogenously less liquid and circumvent regulation by engaging in shadow banking, which leads to a reallocation of funding away from the more liquid price-setter. This reallocation channel underlies the credit boom. Endogenous responses in bank liquidity ratios also affect the magnitude of the boom. We discuss extensions of the model and illustrate its quantitative performance with an application to China.

Suggested Citation

Hachem, Kinda and Song, Zheng Michael, Liquidity Rules and Credit Booms (January 2016). NBER Working Paper No. w21880, Available at SSRN: https://ssrn.com/abstract=2717291

Kinda Hachem (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Zheng Michael Song

University of Chicago ( email )

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