Liquidity Requirements, Free-Riding, and the Implications for Financial Stability Evidence from the Early 1900s
19 Pages Posted: 6 Jun 2018 Last revised: 29 Apr 2020
Date Written: 2018-03-09
Maintaining sufficient liquidity in the financial system is vital for financial stability. However, since returns on liquid assets are typically low, individual financial institutions may seek to hold fewer such assets, especially if they believe they can rely on other institutions for liquidity support. We examine whether state banks in the early 1900s took advantage of relatively high cash balances maintained by national banks, due to reserve requirements, to hold less cash themselves. We find that state banks did hold less cash in places where both state legal requirements were lower and national banks were more prevalent.
Keywords: Financial stability, Free-riding, Liquidity requirements, Reserve requirements
JEL Classification: D40, G38, N21, N41
Suggested Citation: Suggested Citation