| Abstract: |
In this paper, I develop a model that addresses the links between banks’
liquidity outlook and their incentives to take credit risk. Assuming that both
bank-specific liquidity shocks and credit losses are necessary to provoke bank
runs, the model predicts that a bank’s incentives to mitigate its credit risk
by screening decrease if the probability of a bank-specific liquidity shock
declines. This suggests that the benign liquidity outlook prevailing prior to
the subprime crisis may have contributed to the lack of screening by banks
that has been an important causal factor in the crisis. |