Essays on Liquidity, Banking, and Monetary Policy

The first chapter develops a new theory of bank capital requirements. A general equilibrium banking model is constructed in which deposit claims backed by bank assets support secured credit arrangements with limited commitment. Bank capital, a contingent claim on bank assets, is costly to hold when the value of assets is insufficient to support an efficient credit arrangement. However, if there is non-diversifiable aggregate risk, requiring banks to hold additional bank capital in the high-return state can be beneficial since it can relax the limited commitment constraint in the low-return state by affecting asset prices. Thus bank capital requirements can improve economic welfare by trading off the opportunity cost of holding additional bank capital for the benefit from sharing consumption risk. The second chapter contains a study of how private information can restrict liquidity insurance and the implementation of monetary policy. Lack of record-keeping implies that recognizable assets are essential for trade and also generates a private information problem when agents are subject to idiosyncratic liquidity shocks. A banking arrangement with self-selection that improves liquidity provision through the use of two different liquid assets is considered. It is found that when the incentive constraint binds with asset scarcity, there exists a liquidity premium on illiquid assets which reveals private information. The model is extended to include monetary policy, specifically Open-Market-Operations. It is shown that liquidity trap can exist when truth-telling incentive constraints bind