Cash Holdings and Credit Risk

Bank Cash Holdings and Investor Uncertainty

“…As such, liquidity buffers exceeding levels warranted to meet liability holder demands may be evidence of either prudence or nervousness of management faced with potential or impending liquidity issues. Acharya et al (2012) observe outside the financial sector that firms closer to distress are more likely to maintain larger cash buffers. Also, Cornett et al 9 (2011) find that, during the financial crisis of 2007-2009, banks holding more illiquid asset portfolios increased their liquidity buffer and reduced lending.…”

“…First, they can create agency costs, as managers may divert cash to investments that are not in the stockholders' interests (Jensen, 1986). Second, large cash holdings may reflect precautionary actions taken by management faced with risky cash flows to address potential liquidity shortages and reduce the probability of default (Acharya et al, 2012).…”

“…The opacity of such transactions and the purchased assets may unnerve stockholders. Another explanation may be that cash holdings reflect a precautionary stance adopted by management in the presence of heightened default risk (Acharya et al, 2012).…”

“…Primarily, it connects the corporate finance literature on cash holdings, which usually excludes financial institutions from its scope, and the literature on bank liquidity. According to the former, notably Opler et al (1999) and Acharya et al (2012), larger cash holdings reflect precautions taken by management to preserve access to capital markets in spite of riskier cash flows or higher credit risk for investors. According to the latter, notably Calomiris and Kahn (1991) and Flannery (1994), investors 5 have an incentive to monitor their banks' risk-taking and to take action if it exceeds their appetite.…”

Collateral and the Limits of Debt Capacity: Theory and Evidence

“…The project was launched sometime in 5 In a multi-period setting, Acharya, Almeida, and Campello (2007) show that spare debt capacity and cash play a distinct role in liquidity management in connection with future investment opportunities. 6 In a related setting, Acharya, Davydenko, and Strebulaev (2012) revisit the seemingly surprising positive relation between interest rate and cash holdings and show with theory and evidence that the sign of this relation becomes negative once the econometrician accounts for the endogeneity of the cash-level decision at the firm level.…”