Liquidity Risk and Contagion Rodrigo Cifuentes, Gianluigi Ferrucci, and Hyun Song Shin - PowerPoint PPT Presentation

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Liquidity Risk and Contagion Rodrigo Cifuentes, Gianluigi Ferrucci, and Hyun Song Shin

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Simulation exercise, showing that. Contagion via effect on asset prices can be severe ... via asset prices when capital requirements are present (mark to market) ... – PowerPoint PPT presentation

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Title: Liquidity Risk and Contagion Rodrigo Cifuentes, Gianluigi Ferrucci, and Hyun Song Shin


1
Liquidity Risk and ContagionRodrigo Cifuentes,
Gianluigi Ferrucci,and Hyun Song Shin
  • discussion by
  • Arnoud W.A. Boot
  • University of Amsterdam
  • and CEPR

2
Key messages
  • Simulation exercise, showing that
  • Contagion via effect on asset prices can be
    severe
  • Interbank linkages might amplify contagion
    effects via asset prices when capital
    requirements are present (mark to market)
  • This effect is possibly non-monotone in number of
    interbank linkages
  • Liquidity and capital requirements should be set
    in relation to a banks contribution to systemic
    risk

3
Truly important topic
  • Understanding sources/determinants of systemic
    risk (contagion)
  • liquidity risk focus
  • contagion not only via interbank linkages
  • insurance companies
  • hedge funds (LTCM)
  • Implications for regulatory policy
  • focus on capital and liquidity reserve
    requirements

4
Related work
  • Bank panics are not sunspots
  • Gorton (1988) strong correlation between
    business cycles and banking panics in the US
    prior to the creation of the Federal Reserve
  • Calomiris-Gorton (1991) American banking panics
    predictable, i.e. follow stock price declines
    and business failure increases

5
Interbank market as source of contagion
  • We know that interbank market has two effects
  • Reduces the probability that an individual bank
    fails (Bhattacharya-Gale, 1987 ? but further
    underinvestment in liquid asset)
  • Increases the probability of a collapse of the
    entire banking system (Allen-Gale, 2000)
  • paper shows that effect via asset prices
    amplifies this when there are few
    interconnections
  • in the limit (many banks/interconnections) no
    effect

6
Ex ante versus ex post
  • Authors clearly spell-out limitations of the
    analysis
  • Only ex post perspective no tradeoff with ex
    ante incentives
  • True tradeoff requires link with raison dêtre of
    banks
  • banks play also a key role in providing liquidity
  • in Holmstrom-Tirole (1998) access to credit
    lines prevents inefficient liquidations

7
Policy lessons complex
  • Authors claim that liquidity requirements might
    be more effective than capital requirements
  • But are we confusing buffers with requirements?
  • selling liquid asset prevents contagion via asset
    prices, but liquidity requirement would then be
    violated

8
Conclusions
  • Paper makes us very aware of the potential
    importance of contagion via asset prices
  • During rest of the workshop, we need to get a
    feeling for what it truly implies for regulatory
    policy
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