The Liquidity Dynamics of Bank Defaults

Authors


  • We would like to thank an anonymous referee and John Doukas for their helpful comments. We also thank Martin Brown, Matthias Hoffmann, and the participants of the CEQURA 2010 Conference in Munich, the SGF 2011 Conference in Zurich, the Annual Meeting of the German Academic Association for Business Research in Kaiserslautern and the SUERF 2011 Conference in Brussels for their comments and useful discussions on the ideas contained in this paper.

Abstract

We compare liquidity patterns of 10,979 failed and non-failed US banks from 2001 to mid-2010 and detect diverging capital structures: failing banks distinctively change their liquidity position about three to five years prior to default by increasing liquid assets and decreasing liquid liabilities. The build-up of liquid assets is primarily driven by short term loans, whereas long term loan positions are significantly reduced. By abandoning (positive) term transformation throughout the intermediate period prior to a default, failing banks drift away from the traditional banking business model. We show that this liquidity shift is induced by window dressing activities towards bondholders and money market investors as well as a bad client base.

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