Working Paper: CEPR ID: DP8324
Authors: Anatoli Segura; Javier Suarez
Abstract: We develop an infinite horizon model of an economy in which banks finance long term assets by placing non-tradable debt among savers. Banks choose the overall principal, interest rate, and maturity of their debt taking into account two opposite forces: (i) investors' preference for short maturities (which stems from their exposure to preference shocks) and (ii) banks' exposure to systemic liquidity crises (during which debt refinancing becomes specially expensive). Importantly, the terms of access to refinancing during crises depend endogenously on banks' aggregate refinancing needs. Due to pecuniary externalities, the unregulated equilibrium exhibits inefficiently short debt maturities. We analyze the possibility of restoring efficiency or improving welfare by means of limits to debt maturity, Pigovian taxes, and liquidity insurance schemes.
Keywords: liquidity premium; liquidity risk; regulation; maturity structure; pecuniary externalities; systemic crises
JEL Codes: G01; G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banks' equilibrium debt maturities are inefficiently short (G21) | presence of a pecuniary externality (D62) |
| banks face a trade-off between offering short maturities to attract savers (G21) | avoid costly bridge financing during systemic liquidity crises (F65) |
| a crisis occurs (H12) | banks cannot refinance their short-term debt easily (G21) |
| banks' reliance on expensive funds from bridge financiers (G21) | downward-sloping demand for bridge financing during crises (F65) |
| upward-sloping supply based on the heterogeneity of outside investment opportunities (D29) | equilibrium cost of bridge financing (G19) |
| coordinating a properly chosen increase in the maturity of debt across banks (G21) | reduce the overall demand for funds during crises (E44) |
| reduce the overall demand for funds during crises (E44) | lower the equilibrium cost of bridge financing (G19) |
| lower the equilibrium cost of bridge financing (G19) | alleviate banks' financing constraints (G21) |
| introducing a Pigovian tax (H23) | restore efficiency (D61) |