Liquidity Rules and Credit Booms

Kinda Cheryl Hachem, Zheng Michael Song

NBER Working Paper No. 21880
Issued in January 2016, Revised in December 2018
NBER Program(s):Corporate Finance Program, Economic Fluctuations and Growth Program, The Monetary Economics Program

We show that stricter bank liquidity standards can trigger unintended credit booms when there is heterogeneity in interbank pricing power. Attempts to circumvent the regulation change the allocation of savings across institutions, eliciting strategic responses that also change the allocation of lending across markets. More credit is generated per unit of savings in the new equilibrium. A quantitative application to China illustrates the practical relevance of the mechanisms in our model.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w21880

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