Measuring Liquidity Mismatch in the Banking Sector / Arvind Krishnamurthy, Jennie Bai, Charles-Henri Weymuller.

Format:

Book

Author/Creator:

Krishnamurthy, Arvind.

Contributor:

National Bureau of Economic Research.

Bai, Jennie.

Weymuller, Charles-Henri.

Series:

Working Paper Series (National Bureau of Economic Research) no. w22729.

NBER working paper series no. w22729

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2016.

Summary:

This paper implements a liquidity measure, "Liquidity Mismatch Index (LMI)," to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities. We construct the LMIs for 2882 bank holding companies during 2002-2014 and investigate the time-series and cross-sectional patterns of banks' liquidity and liquidity risk. Aggregate banking sector liquidity worsens from +$4 trillion before the crisis to -$6 trillion in 2008, and reverses back to the pre-crisis level in 2009. We also show how a macro-prudential liquidity stress test can be conducted with the LMI metric, and that such a stress test could have revealed the fragility of the banking system in early 2007. In the cross section, we find that banks with more ex-ante liquidity mismatch have a higher stock-market crash probability and are more likely to borrow from the government during the financial crisis. Thus the LMI measure is informative regarding both individual bank liquidity risk as well as the liquidity risk of the entire banking system. We compare the LMI measure of liquidity to other measures such as Basel III's liquidity coverage ratio and net stable funding ratio, and show that LMI performs better in many dimensions. The outperformance of LMI partially results from the contract-specific time-varying liquidity sensitivity weights which are driven by market prices.

Notes:

Print version record

October 2016.