Banks' Liquidity Management and Systemic Risk

43 Pages Posted: 6 Jun 2017

See all articles by Luca Deidda

Luca Deidda

Università degli Studi di Sassari - Department of Economics and Business; Universita di Cagliari - Centre for North South Economic Research (CRENOS)

Ettore Panetti

University of Naples Federico II, CSEF - Center for Studies in Economics and Finance, Students; UECE - Research Unit on Complexity in Economics; SUERF - The European money and finance forum; CSEF - University of Naples Federico II - Centre for Studies in Economics and Finance (CSEF)

Date Written: June 5, 2017

Abstract

We study a novel mechanism through which systemic risk, in the form of self-fulfilling runs, forces the banks to hoard liquidity. To this end, we develop an environment where banks offer insurance to their depositors against both idiosyncratic and aggregate real uncertainty, by holding a portfolio of liquidity and productive illiquid assets. Moreover, banks’ asset portfolios and the probability of a depositors’ self-fulfilling run are jointly determined via a “global game”. In equilibrium, an endogenous pecking order emerges: if the recovery rate associated with early liquidation of the productive assets is sufficiently low and the depositors are sufficiently risk averse, the banks first employ liquidity and then liquidate the productive asset, in order to finance depositors’ withdrawals. Ex ante, the banks hold more liquidity than in a full-information economy, where there are no self-fulfilling runs and risk is only due to idiosyncratic and aggregate real uncertainty.

Keywords: Systemic Risk, Excess Liquidity, Bank Runs, Global Games

JEL Classification: G01, G21

Suggested Citation

Deidda, Luca and Panetti, Ettore, Banks' Liquidity Management and Systemic Risk (June 5, 2017). Available at SSRN: https://ssrn.com/abstract=2980873 or http://dx.doi.org/10.2139/ssrn.2980873

Luca Deidda

Università degli Studi di Sassari - Department of Economics and Business ( email )

via Muroni 25
Sassari, Sassari 07100
Italy

Universita di Cagliari - Centre for North South Economic Research (CRENOS) ( email )

Italy

Ettore Panetti (Contact Author)

University of Naples Federico II, CSEF - Center for Studies in Economics and Finance, Students ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, 80126
Italy

UECE - Research Unit on Complexity in Economics ( email )

ISEG/UTL Rua Miguel Lupi 20
Lisboa, 1249-078
Portugal

SUERF - The European money and finance forum ( email )

PO Box 98
Amsterdam, 1000AB
Netherlands

CSEF - University of Naples Federico II - Centre for Studies in Economics and Finance (CSEF) ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, Naples 80126
Italy

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