Bank Liquidity and the Cost of Debt

39 Pages Posted: 16 Feb 2018

Date Written: January 19, 2018

Abstract

Since the 2007–09 crisis, tougher bank liquidity regulation has been imposed which aims to ensure banks an survive a severe funding stress. Critics of this regulation suggest that it raises the cost of maturity transformation and reduces productive lending. In this paper we build a bank run model with a unique equilibrium where solvent banks can fail due to illiquidity. We endogenise banks’ funding costs as a function of their liquid asset holdings and show how they are negatively related to liquidity, therefore offsetting some of the costs from higher liquidity requirements. We find evidence for this relationship using post-crisis data for US banks, implying that liquidity requirements may be less costly than previously thought.

Keywords: Bank runs, global games, liquidity

JEL Classification: G21, G28

Suggested Citation

Miller, Sam and Sowerbutts, Rhiannon, Bank Liquidity and the Cost of Debt (January 19, 2018). Bank of England Working Paper No. 707. Available at SSRN: https://ssrn.com/abstract=3118309 or http://dx.doi.org/10.2139/ssrn.3118309

Sam Miller (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Rhiannon Sowerbutts

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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