Reducing the Chance of Pulling the Plug on Liquidity

2017-04-15T14:25:36-04:00April 6, 2011|

The near collapse of the financial system that set off the global crisis was due in part to financial institutions suddenly lacking access to funding markets, and liquidity drying-up across securities markets. Financial institutions did not factor in how their own responses to a liquidity shortfall could make the entire system shut down. But, it only takes a few institutions to pull the plug on a liquidity-filled bathtub before it runs dry, and the central bank needs to open the spigots again. The key then is to make sure that firms have less incentive to pull the plug. To do that, in the latest Global Financial Stability Report, we have come up with a way to measure how much an individual financial institution contributes to system-wide liquidity risk.