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Endogenous Asset Fire Sales and Bank Lending Incentives

Cheung Kong Graduate School of Business, 3F, Tower E3, Oriental Plaza, 1 East Chang An Avenue, Beijing 100738, P. R. China

E-mail Address: zzsong@ckgsb.edu.cn

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https://doi.org/10.1142/S2010139221500026Cited by:2 (Source: Crossref)

Abstract

This paper examines the impact of banks’ lending incentives on asset prices and bank cash holdings under liquidity risk. Banks make lending decisions based on the tradeoff between costs (fire sales of illiquid assets) and benefits (high returns from bank loans). This paper shows fire sales of assets can be an endogenous outcome, even if banks are endowed with enough cash to meet liquidity shocks. This paper also helps explain why banks have kept a large amount of cash without lending after government capital injections in the 2008 financial crisis. The model further provides policy implications for government intervention.

Keywords:

JEL: G01, G12, G21, G28

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