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The interdependence of bank capital and liquidity

Author

Listed:
  • Elena Carletti
  • Itay Goldstein
  • Agnese Leonello

Abstract

This paper analyzes the role of liquidity regulation and its interaction with capital requirements. We ?first introduce costly capital in a bank run model with endogenous bank portfolio choice and run probability, and show that capital regulation is the only way to restore the efficient allocation. We then enrich the model to include ?re sales, and show that capital and liquidity regulation are complements. The key implications of our analysis are that the optimal regulatory mix should be designed considering both sides of banks? balance sheet, and that its effectiveness depend on the costs of both capital and liquidity.

Suggested Citation

  • Elena Carletti & Itay Goldstein & Agnese Leonello, 2019. "The interdependence of bank capital and liquidity," BAFFI CAREFIN Working Papers 19128, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    • Handle: RePEc:baf:cbafwp:cbafwp19128
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    More about this item

    Keywords

    illiquidity; insolvency; ?re sales; optimal regulation;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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