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Liquidity Management in Banking: What is the Role of Leverage?


Vo, Thi Quynh Anh (2015). Liquidity Management in Banking: What is the Role of Leverage? Swiss Finance Institute Research Paper 15-51, University of Zurich.

Abstract

This paper examines potential impacts of banks' leverage on their incentives to manage their liquidity. We analyze a model where banks control their liquidity risk by managing their liquid asset positions. In the basic framework, a model with a single bank, where the possibility of selling long-term assets when in need of liquidity is not taken into account, we find that the bank chooses to prudently manage its liquidity risk only when its leverage is low. In a model with multiple banks and a secondary market for long-term assets, we find that a banking system where banks are highly leveraged can be prone to liquidity crises. Our model predicts a typical pattern of liquidity crises that is consistent with what was observed during the 2007-2009 crisis.

Abstract

This paper examines potential impacts of banks' leverage on their incentives to manage their liquidity. We analyze a model where banks control their liquidity risk by managing their liquid asset positions. In the basic framework, a model with a single bank, where the possibility of selling long-term assets when in need of liquidity is not taken into account, we find that the bank chooses to prudently manage its liquidity risk only when its leverage is low. In a model with multiple banks and a secondary market for long-term assets, we find that a banking system where banks are highly leveraged can be prone to liquidity crises. Our model predicts a typical pattern of liquidity crises that is consistent with what was observed during the 2007-2009 crisis.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:31 October 2015
Deposited On:01 Mar 2016 07:50
Last Modified:28 Aug 2017 21:01
Series Name:Swiss Finance Institute Research Paper
Number of Pages:43
Free access at:Official URL. An embargo period may apply.
Official URL:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2696126
Other Identification Number:merlin-id:12654

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