The Risk-Taking Channel of Liquidity Regulations and Monetary Policy
Stephan Imhof, Cyril Monnet and Shengxing Zhang
We develop a theoretical model to study the implications of liquidity regulations and monetary policy on deposit-making and risk-taking. Banks give risky loans by creating deposits that ﬁrms use to pay suppliers. Firms and banks can take more or less risk. In equilibrium, higher liquidity requirements always lower risk at the cost of lower investment. Nevertheless, a positive liquidity requirement is always optimal. Monetary conditions aﬀect the optimal size of liquidity requirements, and the optimal size is countercyclical. It is only optimal to impose a 100% liquidity requirement when the nominal interest rate is suﬃciently low.