The 2007-2009 financial crush that caused not only the collapse of the financial system but also a huge negative effect to the entire economy has emphasized shortcomings liquidity management at financial institutions. The last crisis showed us that the consequences of poor liquidity risk management could affect not only one financial institution but also the entire financial system and going beyond to the global economy. From 2010, The Basel Committee on Banking Supervision introduced a new package of proposals named Basel III, to strengthen management of liquidity risk.
A decade later, many studies have investigated on what happened in the last financial crisis and a variety of reports raise question whether a new one could be on the horizon. As we pass the ten-year anniversary of last global financial crisis, one question about the financial system comes up: Is the history repeating again? There has been much speculation recently in the press about the next possible financial crisis and many economists around the world do not have good news for us. Analysts at J.P. Morgan Chase recently made an announcement of a new predictive model that pencils in the next crisis to hit in 2020. They have warned a potential liquidity risk that may emerge due to a decline in stocks which could cause the so called ''the Great Liquidity Crisis''.
As the alarm bells ringing, we aim to empirically investigate liquidity risk and the credit risk as the two major sources of bank default risk by considering the impact of the new requirements under Basel III on liquidity characteristics. We will use a sample of banks in Italy during the post-crisis period as well as a sample from other European banks and analyze the effects of these two risk sources on the bank institutional-level. This will provide us a comparison between Italian banks and other EU countries under implementation of Basel III characteristics and suggest possible strategies and ways to mitigate future crisis.
As reported by Imbierowicz et al. (2014):
''A joint management of liquidity risk and credit risk in a bank could sub-stantially increase bank stability. Recent regulatory efforts like the Basel III framework put stronger emphasis on the importance of liquidity risk management in conjunction with the asset quality and credit risk of a bank.''
Therefore, as is well known already in the economics literature, liquidity and credit risk coexist and interact. Indeed, these interacting risks are one of the main causes of the last financial crisis. In this framework, the innovative contribution that this study brings to the pool of knowledge on the topic lies on the following aspects:
* Even though there is a continuous debate on the importance of the relationship between risk and banking stability, there are no empirical studies that have examined the impact of credit and liquidity risks on bank stability in the European Union within the framework of Basel III new requirements. Following this, we aim to empirically investigate simultaneously the liquidity risk and the credit risk as the two major sources of banks default by considering the impact of the new requirements under Basel III on liquidity characteristics. This will allow us not only to analyze the relationship between credit risk and liquidity risk for the post-crisis period in the banking sector, but also to investigate if banks have made enough efforts by following the instructions by Basel committee.
* Our research project will provide several recommendations for bank management and bank supervisors among Italian banks by making a comparison with the rest European banks on how they are jointly managing liquidity and credit risk. This study will shed some light to investigate the post-crisis behavior of banks following the new Basel requirements and what is their real effect on the banking stability. Are these new rules effective enough in order to prevent a future similar liquidity crisis as many economists are speculating recently?
* This research will suggest possible strategies and ways to policymakers and bankers in order to mitigate future crisis similar to the last one. An investigation of both credit risk and liquidity risk can give a better insight into the stability and efficiency of banks and the behavior toward these two main sources of banking instability, which as we saw 10 years ago, can affect entire financial system, and going beyond to the global economy.