Working Paper: NBER ID: w15567
Authors: Viral V. Acharya; Hyun Song Shin; Tanju Yorulmazer
Abstract: What is the effect of financial crises and their resolution on banks' choice of liquid asset holdings? When risky assets have limited pledgeability and banks have relative expertise in employing risky assets, the market for these assets clears only at fire-sale prices following a large number of bank failures. The gains from acquiring assets at fire-sale prices make it attractive for banks to hold liquid assets. We show that the resulting choice of bank liquidity is counter-cyclical, inefficiently low during economic booms but excessively high during crises, and present and discuss evidence consistent with these predictions. Since inefficient users may enter asset markets when prices fall sufficiently, interventions to resolve banking crises may be desirable ex post. However, policies aimed at resolving crises affect ex-ante bank liquidity in subtle ways: while liquidity support to failed banks or unconditional support to surviving banks in acquiring failed banks give banks incentives to hold less liquidity, support to surviving banks that is conditional on their liquid asset holdings creates incentives for banks to hold more liquidity.
Keywords: bank liquidity; financial crises; policy interventions
JEL Codes: D62; E58; G21; G28; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial crises (G01) | bank liquidity (G21) |
| bank liquidity (G21) | financial crises (G01) |
| bank liquidity choice (E51) | economic conditions (E66) |
| policy interventions (D78) | bank liquidity choices (E51) |
| unconditional support (Y70) | bank liquidity (G21) |
| conditional support (C62) | bank liquidity (G21) |