Liquidity Risk and Funding Cost

Abstract

We propose and test a new channel that links funding liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the funding liquidity risk channel postulates that borrowers exposed to liquidity shocks are willing to pay a markup for immediate funding. We test and quantify the channel using unique trade-by-trade data and uncover systematic differences across individual banks' funding cost driven by idiosyncratic liquidity risk. These differences are persistent over a decade, suggesting that the funding liquidity risk channel is relevant in general and not only arises during crisis times.

Safe Asset Scarcity and Re-use in the European Repo Market

“…Our measure of dealers' demand for liquidity is the variation in banks' weekly total GC repo transaction volume that is orthogonal to determinants of demand. More specifically, we use the residuals from the following regression model, analog to Bechtel, Ranaldo, and Wrampelmeyer (2022):…”

Funding Liquidity and Risk-Taking: Evidence from the Commercial Banks of Pakistan

“…Econometric model: The study has used a panel regression in line with prior empirical studies like (Bechtel, Ranaldo, & Wrampelmeyer, 2023) to examine the impact of liquidity funding risk on banks' risk-taking. The study has included bank-specific and macroeconomic control variables which can affect risk-taking by the banks.…”