Provision of liquidity by the central bank in times of liquidity crisis

Transcription

1 Provision of liquidity by the central bank in times of liquidity crisis Comment on papers by Sauer, Illing and Cao, Kharroubi and Vidon Nuno Cassola (ECB)

2 3 papers S. Sauer: Liquidity risk and monetary policy G. Illing and J. Cao: Liquidity shortages and monetary policy E. Kharroubi and E. Vidon: Increasing returns in interbank liquidity markets

3 Main objective of the papers Macro-finance paper: Sauer: analyse the impact of liquidity provision by CB on financial markets in response to liquidity shocks Banking papers: Illing and Cao: analyse the interaction between risk taking in the financial sector and central bank policy for the case of pure illiquidity risk Kharroubi and Vidon: analyse functioning of interbank market and occurrence of liquidity crisis when banks face liquidity shocks

4 Main themes of the 3 papers Liquidity provision by CB creates moral hazard which leads to lower investment in liquid assets, higher risk taking and therefore increasing financial fragility Trade-off between financial stability and price stability Bagehot rules for ELA do not address moral hazard issues Liquidity provision is problematic!

5 Key contribution of the 3 papers Frameworks for analysing the impact of CB policies on risk taking by the private sector Link between monetary policy and financial stability can be analysed Liquidity provison takes center stage

6 Macro-finance perspective 3 dates t = 0, 1, 2 Asset market; goods market; labour market (No banks) Liquidity shock may generate a demand shock today and may cause a supply shock tomorrow (transmission channel: cash-constrained entrepreneurs selling financial assets to keep today s consumption)

7 Macro-finance perspective CB policy: repos in shares (cash against shares today and buy back) => creates moral hazard Entrepreneurs invest more in shares and less in cash Trade-offs: higher prices today higher output tomorrow; less cash today more financial crises tomorrow Redistribution from workers to entrepreneurs

8 Banking perspective: Cao and Illing 3 and ½ dates t = 0, 1/2, 1, 2 Entrepreneurs; investors and banks Banks runs possible (t = 1/2) Safe projects and risky projects (may be delayed) All banks are solvent; only liquidity risk Perfect interbank market for liquidity

9 Banking perspective: Cao and Illing Probability of an aggregate liquidity shock neither too high nor too low: banks free-ride on excess liquidity on good states => low liquidity in bad states CB liquidity provision prevents bank runs Probability of an aggregate liquidity shock high: central bank liquidity provision aggravates freeriding Banks that invest in risky projects crowd out more prudent ones

10 Banking perspective: Cao and Illing Intermediate cases are problematic Liquidity injection creates moral hazard CB liquidity provision only to prudent banks Not dynamically consistent Doubts about Bagehot rule

11 Banking perspective: Kharroubi and Vidon 3 periods: t=0, 1, 2 Firms and banks No bank runs Shock to projects (t=1) require aditional funding and effort (monitoring?) High effort by distressed banks if ex-ante liquidity provision high (borrowing lower)

12 Banking perspective: Kharroubi and Vidon Multiple equilibriums in the interbank market Depends on the probability of a liquidity shock Depends on (monitoring) effort

13 Banking perspective: Kharroubi and Vidon Low effort banks may borrow in the interbank market (Asymmetric information) Credit rationing by intact banks

14 Banking perspective: Kharroubi and Vidon Cost of liquidity: Low when the probability of liquidity shock is large (in tranquil times = when all banks deliver high effort) Large when the probability of liquidity shock is large (in crisis times = when distressed banks deliver low effort)

15 A few questions Sauer: Two Concepts of Liquidity Liquidity = Cash Asset Selling with small price effect Cash is costly: no (or negative) return! Entrepreneurs: cash-constrained? Banks are needed! Underlying liquidity policy is heterodox!

16 A few questions Cao and Illing: Two Concepts of Liquidity Liquidity as storage technology (1 unit of real consumption) Investment in safe projects Interbank market not perfect (asymmetric information) Bank runs not prevented by deposit insurance? Role for the supervisor: (Capital requirements?) Liquidity requirements (alpha low bar in C&I)!

17 A few questions Kharroubi and Vidon Concept of liquidity: liquid technology that yields return in all periods (remunerated reserves?) Link between firm and bank: small-firms and/or underdeveloped financial markets Unclear which equilibrium prevails (with or without credit rationing?): very different interest rate determination in the interbank market! CB (and/or FSA) not modelled: unclear policy conclusions!

18 Banking Future Research Topics Securitization (screening moral hazard) Credit risk transfer (monitoring moral hazard) Adverse selection (gambling for ressurection) Policy Collateral in CB operations Reserve requirements Maturity and size of refinancing operations

19 LLR: 21 st century approach Freixas, Parigi, Rochet (JEEA 2004) Potential role for ELA by the CB Supervsion is inefficient (i.e. insolvent banks are not detected) Very costly to screen sound investments (screening moral hazard) Interbank spreads are high (asymmetric information; gambling for ressurection) Central bank loans can be collateralised

20 LLR: 21 st century approach Freixas, Parigi, Rochet (JEEA 2004) Still emergency liquidity provision is a complex issue as it lies at the intersection of Monetary policy Supervison and regulation of banking industry Organisation of interbank market

21 Thank You! Merci!