Measuring Liquidity Mismatch in the Banking Sector

Jennie Bai, Arvind Krishnamurthy, Charles-Henri Weymuller 

This version: July 2015

Abstract
This paper expands on Brunnermeier, Gorton and Krishnamurthy (2011) and implements a liquidity measure, \Liquidity Mismatch Index (LMI)," to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities. We construct the LMIs for 2882 bank holding companies during 2002 - 2014 and investigate the time-series and cross-sectional patterns of banks' liquidity and liquidity risk.The aggregate banking sector liquidity worsens from +$5 trillion before the crisis to -$3 trillion in 2008,and reverses back to the pre-crisis level in 2009. We also show how a liquidity stress test can be conducted with the LMI metric, and that such a stress test as an e ective macroprudential tool could have revealed the liquidity need of the banking system in the late 2007. In the cross section, we nd that banks with more liquidity mismatch have a higher crash probability in the nancial crisis and have a higher chance to borrow from the government during the nancial crisis. Thus our LMI measure is informative regarding both individual bank liquidity risk as well as the liquidity risk of the entire banking system.

JEL Classi cation: G21, G28.

Keywords: liquidity regulation; market liquidity; funding liquidity; macroprudential tool.