Hostname: page-component-586b7cd67f-dsjbd Total loading time: 0 Render date: 2024-11-23T20:53:15.094Z Has data issue: false hasContentIssue false
  • English
  • Français

LIQUIDITY REGULATION AND FINANCIAL STABILITY

Published online by Cambridge University Press:  22 November 2018

Yang Li
Yang Li*
Affiliation:
Nankai University
*
Address correspondence to: Yang Li, Room 562 School of Finance, Nankai University, 38 Tongyan Road, Jinnan District, Tianjin, China, 300350; e-mail: [email protected]. Phone: (+86)13810177850.
Get access Rights & Permissions [Opens in a new window]

Abstract

Anticipating a bailout in the event of a crisis distorts financial intermediaries’ incentives in multiple dimensions. Bailout payments can, for example, lead intermediaries to issue too much short-term debt while simultaneously underinvesting in liquid assets. To correct these distortions, policymakers may choose to regulate the composition of both the assets and liabilities of intermediaries. I examine these regulations in a version of the Diamond and Dybvig [(1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401–419] model with limited commitment. I demonstrate that, contrary to common wisdom, introducing a minimum liquidity requirement can increase intermediaries’ susceptibility to a run by their investors.

Keywords

BailoutsLiquidation CostMacroprudential PolicyTime-Inconsistency
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 5 , July 2020 , pp. 1240 - 1263
Copyright
© Cambridge University Press 2018

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I thank Oriol Carbonell-Nicolau, John Landon-Lane, Hyeon Ok Lee, Yuliyan Mitkov, Byoung Hark Yoo, and the anonymous reviewer for their suggestions. I am especially grateful to Todd Keister for numerous conversations and helpful guidance. All errors remain my own.

References

Adrian, T. and Ashcraft, A. B. (2012) Shadow banking regulation. Annual Review of Financial Economics 4(1), 99–140.CrossRefGoogle Scholar
Adrian, T. and Ashcraft, A. B. (2016) Shadow banking: A review of the literature. In: Jones, G. (ed.), Banking Crises, pp. 282–315. London, UK: Palgrave Macmillan.CrossRefGoogle Scholar
Aldasoro, I. and Faia, E. (2016) Systemic loops and liquidity regulation. Journal of Financial Stability 27, 1–16.CrossRefGoogle Scholar
Allen, F. and Gale, D. M. (2017) How Should Bank Liquidity Be Regulated? SSRN Working Paper.CrossRefGoogle Scholar
Basel Committee on Banking Supervision (BCBS) (2013) Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools.Google Scholar
Bianchi, J. (2016) Efficient bailouts? American Economic Review 106(12), 3607–3659.CrossRefGoogle Scholar
Cooper, R. and Ross, T. W. (1998) Bank runs: Liquidity costs and investment distortions. Journal of Monetary Economics 41(1), 27–38.CrossRefGoogle Scholar
Diamond, D. W. and Dybvig, P. H. (1983) Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91(3), 401–419.CrossRefGoogle Scholar
Ennis, H. M. and Keister, T. (2009) Bank runs and institutions: The perils of intervention. American Economic Review 99(4), 1588–1607.CrossRefGoogle Scholar
Ennis, H. M. and Keister, T. (2010) Banking panics and policy responses. Journal of Monetary Economics 57(4), 404–419.CrossRefGoogle Scholar
Gorton, G. and Muir, T. (2016) Mobile Collateral Versus Immobile Collateral. NBER Working Paper.CrossRefGoogle Scholar
Green, E. J. and Lin, P. (2003) Implementing efficient allocations in a model of financial intermediation. Journal of Economic Theory 109(1), 1–23.CrossRefGoogle Scholar
Kashyap, A. K., Tsomocos, D. P. and Vardoulakis, A. P. (2014) How Does Macroprudential Regulation Change Bank Credit Supply? NBER Working Paper.CrossRefGoogle Scholar
Keister, T. (2016) Bailouts and financial fragility. Review of Economic Studies 83(2), 704–736.CrossRefGoogle Scholar
Keister, T. and Narasiman, V. (2016) Expectations vs. fundamentals-driven bank runs: When should bailouts be permitted? Review of Economic Dynamics 21, 89–104.CrossRefGoogle Scholar
Li, Y. (2017) Interest rates and financial fragility. Journal of Economic Dynamics and Control 82, 195–205.CrossRefGoogle Scholar
Lorenzoni, G. (2008) Inefficient credit booms. Review of Economic Studies 75(3), 809–833.CrossRefGoogle Scholar
Malherbe, F. (2014) Self-fulfilling liquidity dry-ups. Journal of Finance 69(2), 947–970.CrossRefGoogle Scholar
Peck, J. and Shell, K. (2003) Equilibrium bank runs. Journal of Political Economy 111(1), 103–123.CrossRefGoogle Scholar
Peck, J. and Shell, K. (2010) Could making banks hold only liquid assets induce bank runs? Journal of Monetary Economics 57(4), 420–427.CrossRefGoogle Scholar
Perotti, E. and Suarez, J. (2011) A Pigovian Approach to Liquidity Regulation. International Journal of Central Banking 7(4), 3–41.Google Scholar
Shell, K. and Zhang, Y. (in press) Bank runs: The predeposit game. Macroeconomic Dynamics.Google Scholar
Stavrakeva, V. (2017) Optimal bank regulation and fiscal capacity. SSRN Working Paper.Google Scholar
Sultanum, B. (2014) Optimal Diamond-Dybvig mechanism in large economies with aggregate uncertainty. Journal of Economic Dynamics and Control 40, 95–102.CrossRefGoogle Scholar
Wallace, N. (1988) Another attempt to explain an illiquid banking system: The Diamond and Dybvig model with sequential service taken seriously. Federal Reserve Bank of Minneapolis Quarterly Review 12(4), 3–16.Google Scholar
Wallace, N. (1990) A banking model in which partial suspension is best. Federal Reserve Bank of Minneapolis Quarterly Review 14(4), 11–23.Google Scholar
Wellink, N. (2011) Basel III and beyond. Speech at Deutsche Bundesbank.Google Scholar
Yellen, J. L. (2014) Federal Banking Regulators Finalize Liquidity Coverage Ratio. Speech at Federal Reserve Board.Google Scholar
Supplementary material: PDF

Li supplementary material

Appendix

Download Li supplementary material(PDF)
PDF 221.7 KB