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The Liquidity Dynamics of Bank Defaults

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  • Stefan Morkoetter
  • Matthias Schaller
  • Simone Westerfeld

Abstract

We compare liquidity patterns of 10,979 failed and non†failed US banks from 2001 to mid†2010 and detect diverging capital structures: failing banks distinctively change their liquidity position about three to five years prior to default by increasing liquid assets and decreasing liquid liabilities. The build†up of liquid assets is primarily driven by short term loans, whereas long term loan positions are significantly reduced. By abandoning (positive) term transformation throughout the intermediate period prior to a default, failing banks drift away from the traditional banking business model. We show that this liquidity shift is induced by window dressing activities towards bondholders and money market investors as well as a bad client base.

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  • Stefan Morkoetter & Matthias Schaller & Simone Westerfeld, 2014. "The Liquidity Dynamics of Bank Defaults," European Financial Management, European Financial Management Association, vol. 20(2), pages 291-320, March.
    • Handle: RePEc:bla:eufman:v:20:y:2014:i:2:p:291-320
    DOI: 10.1111/j.1468-036X.2011.00637.x
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    2. Vincenzo Russo & Valentina Lagasio & Marina Brogi & Frank J. Fabozzi, 2020. "Application of the Merton model to estimate the probability of breaching the capital requirements under Basel III rules," Annals of Finance, Springer, vol. 16(1), pages 141-157, March.
    3. I‐Ju Chen & Yu‐Yi Lee & Yong‐Chin Liu, 2020. "Bank liquidity, macroeconomic risk, and bank risk: Evidence from the Financial Services Modernization Act," European Financial Management, European Financial Management Association, vol. 26(1), pages 143-175, January.

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