The Interdependence of Bank Capital and Liquidity

60 Pages Posted: 23 Jan 2020

See all articles by Elena Carletti

Elena Carletti

Bocconi University

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Agnese Leonello

European Central Bank, Financial Research Division

Date Written: January 2020

Abstract

This paper analyzes the role of liquidity regulation and its interaction with capital requirements. We first introduce costly capital in a bank run model with endogenous bank portfolio choice and run probability, and show that capital regulation is the only way to restore the efficient allocation. We then enrich the model to include fire sales, and show that capital and liquidity regulation are complements. The key implications of our analysis are that the optimal regulatory mix should be designed considering both sides of banks' balance sheet, and that its effectiveness depend on the costs of both capital and liquidity.

Keywords: illiquidity, insolvency, fire sales, optimal regulation

JEL Classification: G01, G21, G28

Suggested Citation

Carletti, Elena and Goldstein, Itay and Leonello, Agnese, The Interdependence of Bank Capital and Liquidity (January 2020). BAFFI CAREFIN Centre Research Paper No. 2020-128. Available at SSRN: https://ssrn.com/abstract=3523208 or http://dx.doi.org/10.2139/ssrn.3523208

Elena Carletti (Contact Author)

Bocconi University ( email )

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Agnese Leonello

European Central Bank, Financial Research Division ( email )

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
79
Abstract Views
327
rank
328,693
PlumX Metrics