TY - JOUR
T1 - The seeds of a crisis
T2 - a theory of bank liquidity and risk taking over the business cycle
AU - Acharya, Viral
AU - Naqvi, Hassan
PY - 2012/11/1
Y1 - 2012/11/1
N2 - We examine how the banking sector could ignite the formation of asset price bubbles when there is access to abundant liquidity. Inside banks, to induce effort, loan officers are compensated based on the volume of loans. Volume-based compensation also induces greater risk taking; however, due to lack of commitment, loan officers are penalized ex post only if banks suffer a high enough liquidity shortfall. Outside banks, when there is heightened macroeconomic risk, investors reduce direct investment and hold more bank deposits. This 'flight to quality' leaves banks flush with liquidity, lowering the sensitivity of bankers' payoffs to downside risks and inducing excessive credit volume and asset price bubbles. The seeds of a crisis are thus sown.
AB - We examine how the banking sector could ignite the formation of asset price bubbles when there is access to abundant liquidity. Inside banks, to induce effort, loan officers are compensated based on the volume of loans. Volume-based compensation also induces greater risk taking; however, due to lack of commitment, loan officers are penalized ex post only if banks suffer a high enough liquidity shortfall. Outside banks, when there is heightened macroeconomic risk, investors reduce direct investment and hold more bank deposits. This 'flight to quality' leaves banks flush with liquidity, lowering the sensitivity of bankers' payoffs to downside risks and inducing excessive credit volume and asset price bubbles. The seeds of a crisis are thus sown.
KW - Bubbles
KW - Flight to quality
KW - Moral hazard
UR - http://www.scopus.com/inward/record.url?scp=84865558621&partnerID=8YFLogxK
U2 - 10.1016/j.jfineco.2012.05.014
DO - 10.1016/j.jfineco.2012.05.014
M3 - Article
AN - SCOPUS:84865558621
VL - 106
SP - 349
EP - 366
JO - Journal of Financial Economics
JF - Journal of Financial Economics
SN - 0304-405X
IS - 2
ER -