Liquidity Squeeze Research Articles

Share pledge risk and government bailout fund

AbstractThe effects of government bailouts have been extensively examined in the literature. This paper is one of the first to empirically examine the bailout funds established in China in 2018, which aimed to mitigate firms' liquidity squeeze risk caused by share pledges. Utilising a hand‐collected dataset of government bailout funds, this paper finds that stock prices increased when government introduced the bailout fund plan, especially for non‐state‐owned enterprises (SOEs) and firms with small size and share pledges. Long‐term performance of bailed out firms increased as well. Overall, our results provide new evidence that government bailouts have positive effects on financial markets.

DOES ISLAMIC BANKING PROMOTE FINANCIAL STABILITY? EVIDENCE FROM AN AGENT-BASED MODEL

Islamic banking has come to the forefront as being one of the fastest growing branch of the global financial industry in recent years. In this study we evaluate whether coexistence of Islamic and conventional banks promote financial stability. In this respect, we evaluate two types of financial systems: (1) A system solely comprised of conventional banks, (2) a dual system in which conventional and Islamic banks coexist and interact with each other. Accordingly, we design two agent-based models representing aforementioned systems and examine possible contagious effects and causes of bank failures by employing the volatility spillover methodology. We find that Islamic banks greatly promote stability by providing liquidity during financial shocks and create more liquidity per asset compared to conventional banks. We also find that they tend to hold more cash than conventional banks, which cushion the effects of a possible liquidity squeeze. Conventional banks, on the other hand, tend to have reserve deficits, which intensify during shock periods. We conclude that coexistence of both bank types creates a win-win situation and contributes to financial stability.

Kyrgyz Republic

This paper discusses Kyrgyz Republic’s Request for Purchase Under the Rapid Financing Instrument and Disbursement Under the Rapid Credit Facility. The COVID-19 pandemic has been hitting the Kyrgyz economy very hard and created an urgent balance of payments need. All sectors are being impacted with extreme severity as measures are being taken to stop the spread of the virus. Given the unprecedented high level of uncertainty, IMF emergency support under the Rapid Financing Instrument and the Rapid Credit Facility helps provide a backstop and increase buffers and shore up confidence. It also helps to preserve fiscal space for essential COVID- 19-related health expenditure and catalyze donor support. Banks’ capital and liquidity buffers need to be used to absorb credit losses and the liquidity squeeze. Once these buffers are exhausted, the central bank needs to show flexibility on the timing of bringing capital and liquidity above the minimum required, considering the length of the crisis. Expeditious donor support is needed to close the remaining balance of payments gap and ease the adjustment burden.

A critical commentary on the proposals to reform India's financial system in its 2019–20 union budget

The 2019–20 Union budget aims to signal that the economic gains from cleaning of the financial system are likely to be recognizable in the future. The non‐performing assets in commercial banks have dropped substantively in last year subsequent to unprecedented recoveries over the past 4 years due to Insolvency and Bankruptcy Code and other legal measures, provision coverage ratio is now at its highest in 7 years, and domestic credit growth has risen to 13.8%. The government has smoothly carried out the consolidation of public sector banks. However, the drop in banks' NPAs appears to be reflected by a liquidity squeeze and mirrored by mounting NPAs confronting the non‐banking finance company (NBFC). In addition, the problems are acute for the analyzed sub‐group of Housing Finance Corporations. While the government has announced its decision to streamline the regulatory processes within this sub‐sector, it has mandated the banks, the chief source of funds to mobilize capital for the NBFCs that appear vital to revive India's economic growth. The government has raised tax rates for the uber‐rich and import duties on a few articles such as Gold while offering tax credits on affordable housing and electric vehicles. It has attempted to improve the microstructure of the capital markets, mitigate inefficiencies in the pension space and enhance market penetration of insurance and incentivize foreign investment through budgetary proposals. This article offers a critical commentary on the proposed policy actions.

Activism Pressure and the Market for Corporate Assets

We investigate the impact of hedge fund activism on corporate transaction markets. We find that activism targets as well as firms exposed to hedge fund threats increase divestitures and receive more merger bids. On balance, they also make fewer acquisitions, but this effect is entirely due to large firms. Activism targets and firms under hedge fund threats contribute about equally to the overall effect. We estimate that the increase in sales and reduction in purchases of assets reduces real asset liquidity by about 35% for asset sellers in industries with strong activist activity. The liquidity squeeze produces two effects: industry outsiders provide liquidity by purchasing more industry assets, and transaction prices are reduced. We find that activism positively affects the efficiency of divestitures and of acquisitions by small firms when firms are activism targets, but not when they act under activism threat.

Interenterprise Credit and Adjustment during Financial Crises: The Role of Firm Size

AbstractSmall and medium‐sized enterprises (SMEs) suffered a sharp contraction in their borrowing from banks during the Great Recession. Analyzing a large firm‐level database for European countries, the paper shows that trade credit amplified the liquidity squeeze on SMEs, with adverse effects on their real activity. SMEs sharply increased their net trade credit and thus transferred financial resources to larger firms. Given the large weight of SMEs in the economy of European countries, the liquidity squeeze of SMEs likely contributed to the depth of the output fall and the slow recovery in Europe during the Great Recession.

Sovereign collateral as a Trojan Horse: Why do we need an LCR+

Sovereign bonds are widely used as collateral in banks’ funding and trading operations. If a sovereign becomes distressed, the collateral mechanism impairs and banks are suddenly facing significant liquidity calls. Basel III's Liquidity Coverage Ratio (LCR) protects banks against unexpected liquidity calls, but currently excludes sovereign distress. Thus, all banks fulfilling the LCR are still exposed to a liquidity risk stemming from distressed sovereign debt and materializing through the collateral channel. Our paper shows that this unaddressed risk can translate into a system-wide liquidity shock. To gauge the potential damage caused by such a shock, we develop a model based on banks’ home sovereign exposures and a bundle of simplifying assumptions in which sovereign distress triggers bank distress. Our model describes how deteriorating sovereign collateral can lead to an overall liquidity squeeze and non-compliance with Basel III liquidity standards. As this risk is too material to be neglected, we propose an alternative version of the LCR, LCR+, which includes the liquidity impact of sovereign distress.

Investment Appeal and Development Strategies of Small Businesses

В статье представлены результаты исследования инвестиционной привлекательности субъектов малого и среднего предпринимательства в период c 2013-го по III квартал 2016 года. Выявлено изменение настроений представителей бизнеса в период 2015-2016 годов в связи с влиянием рецессии и снижения покупательной способности и высокой зависимости субъектов предпринимательства от частного потребления. Данные эмпирического исследования свидетельствуют о сокращении доходности бизнеса и об ухудшении качества управления расходами, обусловленного влиянием таких факторов, как обвал рубля в декабре 2014 года («черный вторник») и последовавшее за этим сжатие ликвидности. Результаты исследования по итогам 2014 года свидетельствуют об одинаковой степени инвестиционной привлекательности малого бизнеса Москвы, Санкт-Петербурга и других регионов России. Однако значения стоимости бизнеса, которые отражают его полезность для собственников, в регионах существенно ниже. Это объясняется более скромными ожиданиями отдачи на вложенный капитал, чем в мегаполисах России. Рассмотрен механизм коллективных инвестиций (краудинвестинг) в частный бизнес, отмечены его достоинства и недостатки. Данный механизм может стимулировать приток частных инвестиций и расширение внутреннего рынка капитала. По оценке Центрального банка, объем рынка краудинвестинговых заимствований в РФ по итогам 2015 года составил всего 52,5 млн руб., тогда как согласно отчету компании Massolution оцениваемый объем инвестиций в мире составил 34 млрд долл., что является еще одним подтверждением зачаточного состояния данного механизма в России. Для эффективного использования механизма необходимо формирование нормативно-правовой базы, позволяющей защитить интересы частных инвесторов, установить регулирование рынка p2b-заимствований и обеспечить широкий доступ физических лиц.

Sovereign Collateral as a Trojan Horse: Why Do We Need an LCR

Sovereign bonds are crucial for both sovereign funding and bank funding. Banks borrow in repo transactions against sovereign creditworthiness rather than their own creditworthiness. However, Basel III's current LCR does not protect banks against sovereign bond distress. Accordingly, currently compliant banks can be exposed to a neglected liquidity risk stemming from distressed sovereign debt moving through the collateral channel. This unaccounted risk can translate into a system wide liquidity shock. To gauge the potential damage caused by such a shock, we have developed a model in which sovereign distress triggers bank distress. Our model shows how deteriorating sovereign collateral can lead to an overall liquidity squeeze and non compliance with Basel III's liquidity standards. Since this risk is highly material, we conclude that LCR should address this event, and we call for an altered version - LCR. LCR is the current LCR adjusted for the liquidity impact of sovereign distress. As envisioned, LCR could have better protected banks against the non-acceptance of Greek and Irish collateral by requiring them to maintain an additional reserve against such an event.

Do exchange rate arrangements and capital controls influence international capital flows and housing prices in Asia?

This paper investigates the influence of international capital flows on housing prices in eight Asian countries, including China. We focus on determining whether exchange rate arrangements and capital regulations influence capital inflows and housing prices. Our results show that an arrangement to restrain the fluctuation of the exchange rate and capital controls has the potential to raise housing prices in Asia. The strong prospect of the Chinese yuan's appreciation also pushed up housing prices in China. Another expected reason for the increase in capital inflows into Asian markets is the expansion of global liquidity. Such capital flows often have a sensitive reaction to market sentiment, and an increase in asset market volatility caused by the liquidity squeeze decreases Asian housing prices. These results suggest the need to review capital controls and future exchange rate system options for Asian countries.

The Institutional Innovation of the Lender of Last Resort Facility in the Eurozone

ABSTRACTThe eurozone has experienced a liquidity squeeze since the outbreak of the European debt crisis, leading to a crisis of confidence. Whether the European Central Bank (ECB) can become the Lender of Last Resort (LLR) has become the focus of discussions. The author begins by clarifying the definition of the LLR, and then analyses the possibility of the ECB or other institutions assuming the role of the LLR, taking into account the eurozone’s special economic governance model and legal framework. As the conclusion shows, with the introduction of Outright Monetary Transactions (OMTs), a debt-purchasing programme, the ECB and the European Stability Mechanism (ESM) will jointly act as the eurozone LLR.

Excess Liquidity and Commodity Boom

 Abstract—This paper presents an investigation of whether excess liquidity has been serving as a driving force for the increase in international commodity prices. This study uses a structural VAR model including two global liquidity indicators and the world production index to examine the determinants of international commodity prices. The lending of tolerant international bankers promoted commodity price might increase before the global financial crisis while the international liquidity squeeze brought about their decline after the Lehman Shock. Among commodities, the prices of industrial metals are more attributable to funding liquidity, and the price of crude oil, with a market believed to be more vulnerable to speculative money inflows, has been less dependent on liquidity. Gold is exceptional. It acted as a safe haven during the period of international financial dysfunction.

Surreptitious structure of the Turkish financial crisis 2000-2001

In this paper, we develop a comprehensive framework to obtain a ‘broad definition’ of overall public debt stock accumulation in Turkey. To do this first, we identify ‘invisible balance’ of public sector incurred from politically backed (informal) off-budget debt-creating transactions among public entities. Then, we compute the stock of hidden liabilities accumulated in the form of persistent deficits of invisible balance from 1989 to 2010. We showed that the overhang of public debt was in play in 2000–2001 crisis episodes. Finally, we analyse both hidden debts and overall debt stock on phase-space and show that debt dynamics follow a chaotic path, generating instability on fiscal structure and increasing vulnerability of the economy to the financial crisis through liquidity squeeze arose in state financial enterprises.

Revenge of the Optimum Currency Area

Revenge of the Optimum Currency Area

Valuing Financial Assets with Liquidity Discount: An Implication for Basel III

The unprecedented financial crisis in 2007 and 2008 and the largest bankruptcy in U.S. history prompted expedited regulation in the financial industry. A new Basel Accord has been proposed to further regulate the main risk that caused the crisis: liquidity risk. In a recent article, Chen [2012] presents a liquidity discount model in which financial securities can be evaluated with substantial discounts at the presence of a liquidity squeeze in the marketplace. In this article, we adopt this model to evaluate a selection of the 23 largest U.S. financial institutions (assets over $100 billion) to investigate the liquidity impact during the crisis period. We calibrate the model to market information such as market capitalization and volatility. We find that the model can provide significant predictive power of a bank’s liquidity health.

Benefits from Lending Relationships in Public Debt Markets: Empirical Evidence from the Commercial Paper Market

There is a large and growing body of literature on the benefits of established lending relationships with banks, which is an intermediated debt market. We extend that literature by testing for benefits from direct lending relationships in the commercial paper market, which is a public debt market. Diamond (1991) suggests that firms access public debt markets when they have enough reputation to no longer require the close monitoring by banks. Using daily rate data for dealer-placed and directly placed commercial paper, we find that the year-end liquidity squeeze is less pronounced in the directly place commercial paper than in the dealer-placed commercial paper, consistent with the existence of benefits from direct lending relationships in this public debt market.

Empty talk? University voices on the Global Financial Crisis

The global financial crisis (GFC) which began in 2007 with a liquidity squeeze in the US banking system and which continues to play out today has affected us all, whether through the collapse of the finance company sector, rising unemployment, falling housing prices or the recession which followed the initial market crash. The speed and scope of the crisis surprised most experts – policy makers included. Specialists from a myriad of disciplines, from economics and finance to risk management, corporate governance and property, are trying to make sense of what happened, why it happened and what it means for us now and into the future. Members of the public rely on the news media to keep them informed of the crisis as it unfolds and they rely on experts to translate these complex events into a language which they can understand. The GFC is educating us all, and it is important that we all learn from it to avoid making the same mistakes again.

Was IMF-Imposed Economic Regime Change in Korea Justified? The Political Economy of IMF Intervention

As late as October 1997 the IMF declared that the Korean economy was experiencing a temporary liquidity squeeze, not a solvency crisis. Yet in December 1997 Deputy Managing Director Stanley Fischer declared that Korea suffered from a systemic “breakdown of economic relations” so complete that only radical economic restructuring could restore prosperity. The IMF attached what it called “extreme structural conditionality” to its loan agreements with Korea, demanding a complete and rapid transition from Korea's traditional East Asian economic model to a globally integrated neoliberal model. We subject the IMF's assertion that the allocative efficiency of the Korean economy had collapsed by 1997 to a number of empirical tests. The evidence does not support the IMF's systemic breakdown claim. We conclude that the IMF's imposition of “extreme structural conditionality” on Korea is best understood as an illegitimate and antidemocratic exercise of power designed to meet the needs of the IMF's key constituents rather than those of the majority of Korea's people.

Spain: 2008 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion

This 2008 Article IV Consultation highlights that after 15 years of impressive growth led by a housing boom, the Spanish economy has entered a sharp downturn in the wake of the global liquidity squeeze since mid-2007. Executive Directors have commended the authorities for their timely and substantial fiscal and financial sector responses to help cushion the downturn. They have emphasized that these efforts need to be complemented by reforms to bolster competitiveness and to avoid a prolonged period of slow growth and high unemployment.

The Creditor Channel of Liquidity Crises

This paper builds a model to analyze how a financial institution can be trapped into a liquidity squeeze through the creditor channel. In the model, a borrower (e.g., a hedge fund) obtains funds from a wholesale large lender (e.g., a prime-broker) and small investors (e.g., client investors). When the large lender's asset market is hit by a liquidity shock, the large lender might decide to withdraw funding extended to the borrower. The potential withdrawal by the large lender causes small investors to panic, and 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 the withdrawals by the creditors. The model helps to explain that the spreading of liquidity shocks from the broker dealer sector to the hedge funds sector and the feedback caused severe illiquidity to hedge funds, which in turn contributed to the systemic crisis in 2007-2009.