Liquidity networks in banking

Eda Orhun, Zayed University

Document Type

Article

Source of Publication

Finance a Uver - Czech Journal of Economics and Finance

Publication Date

1-1-2017

Abstract

© 2017, Faculty of Social Sciences. All rights reserved. Modern financial and banking systems are very much interconnected. In a setting where banks are prone to liquidity risk due to early withdrawals by depositors, this paper analyzes the optimal liquidity network relationship that banks will settle. The paper interprets the network relationship as the exchange of ’committed credit lines’ contracts between the banks. The paper shows that the given liquidity network of Allen and Gale (2000) is one of the optimal solutions that may occur and a risk-based pricing takes place in the interbank market. Banks dispose of their liquidity risk and reduce the total required cash holdings of the banking system to cover early withdrawals by means of this relationship. Additionally, the paper considers the case where liquidity shocks of banks become imperfectly negatively correlated. The network relationship between banks under imperfectly negatively correlated shocks is even robust to the extreme case, in which there is no reduction in the total required cash holdings of banks.

ISSN

0015-1920

Publisher

Faculty of Social Sciences

Volume

67

Issue

2

First Page

104

Last Page

118

Disciplines

Business

Keywords

Cash holdings, Deposit withdrawals, Imperfectly negatively correlated shocks, Interbank market, Liquidity networks

Scopus ID

85018324269

Indexed in Scopus

yes

Open Access

no

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