Working Paper: CEPR ID: DP17811
Authors: Joshua Bosshardt; Ali Kakhbod; Farzad Saidi
Abstract: We examine how banks' liquidity requirements affect their incentives to take risk with their remaining illiquid assets. Our model predicts that banks with more stable liabilities are more likely to increase risk taking in response to tighter liquidity requirements. This prediction is borne out in transaction-level data on corporate and mortgage loans for U.S. banks subject to the liquidity coverage ratio (LCR). For identification, we exploit variation in long-term bank bonds held by insurance companies that are not affected by the LCR. Our results highlight a trade-off between bank risk taking and simultaneously curbing short-term and long-term liquidity-risk exposures.
Keywords: Bank risk taking; Insurance sector; LCR
JEL Codes: G20; G21; G22; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banks with more stable liabilities (G21) | risk-taking behavior (D91) |
| tighter liquidity requirements (G28) | riskier loan originations (G21) |
| banks that rely on long-term funding from insurance companies (G21) | increase in their liquid assets (G33) |
| tighter liquidity requirements (G28) | risk-taking behavior (D91) |
| long-term funding from insurance companies (G22) | greater propensity to engage in riskier loan originations (G21) |