Becker Friedman Institute
for Research in Economics
The University of Chicago

Research. Insights. Impact. Advancing the Legacy of Chicago Economics.

Liquidity Requirements, Liquidity Choice and Financial Stability

December 2015
Douglas Diamond, Anil Kashyap

We study a modification of the Diamond and Dybvig (1983) model in which the bank may hold a liquid asset, some depositors see sunspots that could lead them to run, and all depositors have incomplete information about the bank’s ability to survive a run. The incomplete information means that the bank is not automatically incentivized to always hold enough liquid assets to survive runs. Regulation similar to the liquidity coverage ratio and the net stable funding ratio (that are soon be implemented) can change the bank’s incentives so that runs are less likely. Optimal regulation would not mimic these rules.