Liquidity and Transparency in Bank Risk Management

IMF Working Papers, January 18, 2013

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Liquidity and Transparency in Bank Risk Management

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Bibliographic details

• Authors: Lev Ratnovski
• Published: January 18, 2013
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781616356774.001

Summary of core arguments

• Banks face the risk of being unable to refinance short-term liabilities in case of solvency concerns.
• Two principal management strategies:
  • Accumulate a buffer of liquid assets.
  • Strengthen transparency to communicate solvency to markets.
• Comparative properties of the strategies:
  • A liquidity buffer provides complete insurance against small shocks.
  • Transparency covers also large shocks but imperfectly.
• Incentive and regulatory tensions:
  • Due to leverage, an unregulated bank may choose insufficient liquidity buffers and insufficient transparency.
  • The regulatory response is constrained:
  • Liquidity buffers can be imposed by regulation.
  • Transparency is not verifiable and therefore cannot be imposed in the same way.
  • Liquidity requirements can compromise banks' transparency choices and increase refinancing risk.
• Policy implication:
  • To be effective, liquidity requirements should be complemented by measures that increase bank incentives to adopt transparency.

Key findings and mechanisms

• Liquidity buffers:
  • Provide full insurance against small shocks.
  • Can be mandated by regulators.
  • May have unintended consequences on banks' transparency choices.
• Transparency:
  • Helps communicate solvency and can cover large shocks, though imperfectly.
  • Is not verifiable by regulators, limiting direct regulatory enforcement.
• Interaction effects:
  • Imposing liquidity requirements alone can reduce incentives for banks to adopt transparency, which may increase overall refinancing risk.
  • Effective policy requires combining liquidity regulation with measures that strengthen incentives for transparency.

Policy recommendations

• Do not rely solely on liquidity requirements.
• Complement liquidity requirements with measures that increase bank incentives to adopt transparency.

Subjects and keywords

• Subject: Bank solvency, Banking, Hedging, Liquidity requirements, Liquidity risk
• Keywords: bank liquidity, compromise bank transparency choice, liquidity crisis, market failure, WP

IMF Working Papers — Liquidity and Transparency in Bank Risk Management (Working Paper No. 2013/016)

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