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The Creditor Channel of Liquidity Crises
Author(s) -
LIU XUEWEN,
MELLO ANTONIO S.
Publication year - 2017
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12411
Subject(s) - market liquidity , creditor , shock (circulatory) , liquidity crisis , business , lender of last resort , monetary economics , interbank lending market , financial system , funding liquidity , liquidity risk , asset (computer security) , hedge fund , economics , finance , debt , monetary policy , central bank , medicine , computer security , computer science
This paper presents a model to study the transmission of liquidity shocks across financial institutions through the creditor channel. In the model, a borrower institution obtains funds from a large institutional lender and small investors. When the large lender's asset market is hit by a liquidity shock, it might decide to withdraw funding extended to the borrower. The potential withdrawal by the large lender causes small investors to panic and to close positions even if the large lender does not. Facing funding problems, the borrower has to cut its activities, contributing to further shocks to the supply of market liquidity. The original shock is exacerbated, which reinforces withdrawals by all creditors. The model helps explain how the spreading of liquidity shocks from the broker–dealer sector to the hedge fund sector and the feedback contribute to a systemic crisis.