The authors examine the effect of a trade-off between shared credit risk and liquidity efficiency, among participants in Tranche 2 of the Large Value Transfer System (LVTS T2), on their decisions to leave open, or close, their bilateral credit limits (BCLs) to a participant at risk of imminent closure.
The author develops a dynamic model of banking competition to determine which capital instrument is most effective in disciplining banks' risk choice. Comparisons are conducted between equity, subordinated debentures (SD), and uninsured deposits (UD) as funding sources.
The author develops a theoretical model of bank closure. The regulatory decision about bank failure consists of two parts: whether to close and how to close.
