Working Paper: CEPR ID: DP8706
Authors: Viral V. Acharya; Nada Mora
Abstract: Can banks maintain their advantage as liquidity providers when they are heavily exposed to a financial crisis? The standard argument - that banks can - hinges on deposit inflows that are seeking a safe haven and provide banks with a natural hedge to fund drawn credit lines and other commitments. We shed new light on this issue by studying the behavior of bank deposit rates and inflows during the 2007-09 crisis. Our results indicate that the role of the banking system as a stabilizing liquidity insurer is not one of the passive recipient, but of an active seeker, of deposits. We find that banks facing a funding squeeze sought to attract deposits by offering higher rates. Banks offering higher rates were also those most exposed to liquidity demand shocks (as measured by their unused commitments, wholesale funding dependence, and limited liquid assets), as well as with fundamentally weak balance-sheets (as measured by their non-performing loans or by subsequent failure). Such rate increases have a competitive effect in that they lead other banks to offer higher rates as well. Overall, the results present a nuanced view of deposit rates and flows to banks in a crisis, one that reflects banks not just as safety havens but also as stressed entities scrambling for deposits.
Keywords: financial crisis; flight to safety; liquidity; liquidity risk; solvency risk
JEL Codes: E4; G01; G11; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher rates (E43) | Increased deposit inflows (F65) |
| Banks facing funding squeezes (G21) | Higher rates (E43) |
| Inter-bank competition (G21) | Higher rates (E43) |
| Higher rates (E43) | Banks competing with others (G21) |
| Liquidity demand shocks (E41) | Higher rates (E43) |
| Banks exposed to liquidity demand shocks (F65) | Higher rates (E43) |