Liquidity Transformation and Fragility in the Us Banking Sector

58 Pages Posted: 14 Sep 2020 Last revised: 18 Nov 2021

See all articles by Qi Chen

Qi Chen

Duke University - Fuqua School of Business

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Zeqiong Huang

Yale School of Management

Rahul Vashishtha

Duke University

Multiple version iconThere are 2 versions of this paper

Date Written: September 2020

Abstract

We provide the first large-scale evidence that liquidity transformation by banks creates fragility, as uninsured depositors face an incentive to withdraw money before others (a so-called panic run). Such fragility manifests itself in stronger sensitivity of deposit flows to bank performance. The fragility is stronger when the aggregate conditions in the banking system deteriorate. Multiple analyses show that depositors’ motives are not driven purely by fundamentals, but reflect an element of panic. We analyze the tradeoff banks face when setting their level of liquidity transformation, and show how they use deposit insurance to mitigate some of its negative effects.

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Suggested Citation

Chen, Qi and Goldstein, Itay and Huang, Zeqiong and Vashishtha, Rahul, Liquidity Transformation and Fragility in the Us Banking Sector (September 2020). NBER Working Paper No. w27815, Available at SSRN: https://ssrn.com/abstract=3692171 or http://dx.doi.org/10.2139/ssrn.3692171

Qi Chen (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
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Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
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Zeqiong Huang

Yale School of Management ( email )

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Rahul Vashishtha

Duke University ( email )

Durham, NC 27708-0204
United States
919-660-7755 (Phone)
91-660-7971 (Fax)

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