SAN FRANCISCO—A new study suggests that banks are at risk of not having enough short-term liquidity (certificates of deposits) during the next financial crisis that would be needed to comply with the latest liquidity requirements of the FDIC.
That's because interest rates on deposits lack the ability to attract term deposits during times of high money anxiety, according to a new peer reviewed scientific study titled Dynamics of Yield Gravity by Dr. Dan Geller and Professor Nahum Biger.
The authors noted that stringent liquidity requirements were put in place after the financial crisis of 2008-2009, when banking regulators worldwide established new guidelines at their conference in Basel, Switzerland. The latest Basel III Revised Liquidity Framework requires banks to maintain some level of their bank deposits for a period of one year and over in order to cover losses from loan defaults and avoid a repeat of the need for a government bailout of banks. However, the authors said that the new study shows that higher interest rates failed to attract term deposits during the Great Recession due to diminishing gravitational pull, thus placing banks at a greater risk of default during the next major financial crisis.
The study shows that during the Great Recession and its aftermath, 2008-2012, the average rate of CDs was nearly five times that of liquid accounts (checking, savings and money market). Yet the amount of bank deposits in CDs decreased by 22%, while balances of liquid accounts increased by 78.9%. Moreover, the study shows that during the same time period of 2008-2012, the Money Anxiety Index, used to measure the level of financial stress and anxiety, increased from 58.8 (May 2008) to 100.82 (June 2012), according to the authors.
"The implications of this study," said Geller, "suggest that financial institutions should incorporate behavioral economics into their forecasting and pricing models to ensure that deposit rates are optimally positioned to control interest expense and manage required liquidity levels."
"Moreover," added Professor Biger, "recognition of the dynamics of yield gravity phenomenon by the banking, economics and finance sectors is the starting point in developing measures to offset the adverse impact diminishing gravity of yield has on interest expense and long-term liquidity."
Geller and Biger said they were invited to present and publish the "Dynamics of Yield Gravity" paper after it passed a double-blind peer review by two international conferences on economics and finance.