Liquidity risk and fair value accounting : implications for banks capital structure, lending and stability.

Summary This thesis includes three empirical tests based on data from U.S. commercial banks. It aims to highlight the implications of liquidity risk and fair value accounting on banks' capital structure, lending and stability. Thus, the first chapter examines whether episodes of market liquidity shortages influence the adjustment of banks' capital structure. The results reveal that only small banks respond to such episodes by increasing their capital ratio. They do so by reducing the share of loans in total assets, decreasing the share of assets with a higher risk weight and reducing the size of their balance sheet. These results suggest that liquidity requirements may be redundant for small banks, but appear necessary for large banks. The second chapter analyzes whether the impact of an unexpected flow of deposits on loan creation depends on the degree to which banks are exposed to liquidity risk from the off-balance sheet. The results show that only small banks increase their lending when they are subject to unexpected deposit inflows. This increase in lending depends on their degree of exposure to liquidity risk from their off-balance sheet activities. Smaller banks with greater exposure to liquidity risk tend to make fewer new loans. These results suggest that unexpected inflows of deposits may not be as easily redistributed to borrowers. The third chapter examines the effect of level 2 and level 3 assets held by banks on risk taking and insolvency risk. The results reveal that banks with higher proportions of Tier 2 and Tier 3 assets take on more risk and are more exposed to insolvency risk. These results suggest that the banking system may become more fragile when investors perceive reliability problems with bank assets.