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Bank liquidity, bank lending, and "bad bank" policies

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  • Morrison, Alan D
  • Wang, Tianxi

Abstract

Why are bank deposits demandable when they are also negotiable? We present a General Equilibrium model in which demandable debt exposes banks to liquidity risk so that they can signal their types and ensure that their liabilities can circulate as a means of payment. Banks can manage their liquidity risk by altering their deposit rate and their lending scale. When banks are transparent, so that depositors have homogenous information about their assets, they use only the former tool: their lending scale is effcient, and they do not experience liquidity crisis. When banks are opaque, so that depositors receive private signals of their quality, they ineffciently shrink the scale of their lending. A bank's stock of liquid assets affects its capacity for risk taking. A "bad bank" policy can resolve liquidity crises by reducing the opacity of the bank's assets.

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  • Morrison, Alan D & Wang, Tianxi, 2021. "Bank liquidity, bank lending, and "bad bank" policies," Economics Discussion Papers 29501, University of Essex, Department of Economics.
    • Handle: RePEc:esx:essedp:29501
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    Keywords

    Liquidity crises; demandable deposits; negotiable deposits; bad bank policies;
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