A learning-based theory of cash requirements
Event details
| Date | 24.05.2016 |
| Hour | 12:30 › 13:30 |
| Speaker | Damien KLOSSNER (PhD student, SFI@EPFL) |
| Location | |
| Category | Conferences - Seminars |
Absent a lender of last resort, cash is a buffer against liquidity crises. In the presence of a central bank, however, liquidity is a public choice and hoarding cash may be irrelevant if a bail-out is expected. In our paper, the bail-out decision is endogenous and trades off liquidation vs. moral hazard. This, in turn, impacts the ex ante incentives of banks to build cash reserves. The privately optimal buffer strongly depends on bail-out expectations and does not necessarily coincide with the socially optimal protection. The bank can choose a portfolio with inefficiently high liquidity risk such that the ex post optimal decision of the central bank following a liquidity crisis is to bail out. One novelty of our approach is to add a supervisory opportunity for the central bank in a context of asymmetric information. Learning strongly shifts the ex ante private incentives to hoard cash. Our model shows that the direction of this shift depends on the central bank's prior about the bank, while its magnitude depends on the opacity of the bank. We argue that central bank involvement is irreversible, so that the learning process must take place before the liquidity crisis. In the model, supervision starts when cash reserves fall below some threshold, which we interpret as a liquidity coverage ratio. The welfare gain of such a liquidity requirement can be mapped to the fundamentals and the opacity of the bank.
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