Bank's Liquidity Management and Financial Fragility

CRENOS Working Papers (quaderni di ricerca), 2018

55 Pages Posted: 2 Oct 2019 Last revised: 20 Oct 2019

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: 2018

Abstract

We propose a novel theory of banks’ liquidity management and financial fragility. Banks hold liquidity and an illiquid productive asset, thereby engaging in maturity transformation, and insure their depositors against idiosyncratic and aggregate shocks. However, strategic complementarities in the depositors’ withdrawal decisions might trigger a self-fulfilling run, modelled as a “global game”. In equilibrium, if the liquidation of the productive asset is sufficiently costly and the depositors are sufficiently risk averse, banks manage their liquidity needs during runs following an endogenous pecking order: they first deplete liquidity, and then liquidate the productive asset. Thus, under these conditions banks subject to runs are first illiquid but solvent, and then become insolvent. Ex ante, if the probability of the idiosyncratic shock is sufficiently large, banks hoard liquidity, and narrow banking is not viable.

Keywords: banks, liquidity, financial fragility, self-fulfilling runs, global games, narrow banking

JEL Classification: G01, G21, G28

Suggested Citation

Deidda, Luca and Panetti, Ettore, Bank's Liquidity Management and Financial Fragility (2018). CRENOS Working Papers (quaderni di ricerca), 2018, Available at SSRN: https://ssrn.com/abstract=3459445 or http://dx.doi.org/10.2139/ssrn.3459445

Luca Deidda (Contact Author)

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

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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
49
Abstract Views
353
PlumX Metrics