How Do Banks Manage Liquidity Risk? Evidence from the equity and deposit markets in the Fall of 1998

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How Do Banks Manage Liquidity Risk? Evidence from the equity and deposit markets in the Fall of 1998

by Evan Gatev of Boston College,
Til Schuermann of the Federal Reserve Bank of New York & Wharton, and
Philip E. Strahan of Boston College, Wharton , & NBER

February 2005

Abstract: We report evidence from the equity market that unused loan commitments expose banks to systematic liquidity risk, especially during crises such as the one observed in the fall of 1998. We also find, however, that banks with higher levels of transactions deposits had lower risk during the 1998 crisis than other banks. These banks experienced large inflows of funds just as they were needed -- when liquidity demanded by firms taking down funds from commercial paper backup lines of credit peaked. Our evidence suggests that combining loan commitments with deposits mitigates liquidity risk, and that this deposit-lending synergy is especially powerful during periods of crisis, when nervous investors move funds into their banks.

JEL Classification: G18, G21.

Keywords: Liquidity, banking, financial crisis.

This paper is republished as Ch.3 in…