Liquidity Shortages and Inefficient Bank Lending

This paper develops a simple model of bank lending and liquidity shortages. Firms borrow from banks in the form of long term renegotiable deposit contracts. Banks themselves are financed through uninsured non-renegotiable deposit contracts. Bank liquidity plays a crucial role in the intermediation process and shortages can overhang implementation of efficient investment financing. It is argued that bank equity issues and introducing secondary markets for bank loans will not resolve the problem. Banks cannot always provide liquidity for consumption smoothing and provide liquidity to firms. the implications of this for firms' project choices are explored. 

Download is not available