DP9162 Liquidity Coinsurance and Bank Capital

Author(s): Fabio Castiglionesi, Fabio Feriozzi, Gyöngyi Lóránth, Loriana Pelizzon
Publication Date: October 2012
Keyword(s): Bank Capital, Interbank Markets, Liquidity Coinsurance.
JEL(s): G21
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9162

Banks can deal with their liquidity risk by holding liquid assets (self-insurance), by participating in the interbank market (coinsurance), or by using flexible financing instruments, such as bank capital (risk-sharing). We study how the access to an interbank market affects banks' incentive to hold capital. A general insight is that from a risk-sharing perspective it is optimal to postpone payouts to capital investors when a bank is hit by a liquidity shock that it cannot coinsure on the interbank market. This mechanism produces a negative relationship between interbank activity and bank capital. We provide empirical support for this prediction in a large sample of U.S. commercial banks, as well as in a sample of European and Japanese commercial banks.