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Liquidity Management in Banking: What is the Role of Leverage?

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  • Quynh Anh VO

    (University of Zurich)

Abstract

This paper examines potential impacts of banks' leverage on their incentives to manage their liquidity. We analyse a model where banks control their liquidity risk by managing their liquid asset positions. In the basic framework, a model with a single bank, where the possibility of selling long-term assets when in need of liquidity is not taken into account, we find that the bank chooses to prudently manage its liquidity risk only when its leverage is low. In a model with multiple banks and a secondary market for long-term assets, we find that a banking system where banks are highly leveraged can be prone to liquidity crises. Our model predicts a typical pattern of liquidity crises that is consistent with what was observed during the 2007-2009 crisis.

Suggested Citation

  • Quynh Anh VO, 2015. "Liquidity Management in Banking: What is the Role of Leverage?," Swiss Finance Institute Research Paper Series 15-51, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1551
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    File URL: http://ssrn.com/abstract=2696126
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    More about this item

    Keywords

    Leverage; Liquidity Risk; Moral Harzard; Cash-In-The-Market Pricing;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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