Liquid Assets in Banks: Theory and Practice

This paper summarizes theoretical findings on the determinants of liquid assets held by banks. The findings are summarized in a series of predictions, some of which are tested using a panel data set on Mexican banks. Surprisingly, we find that banks with relatively more demand deposits have relatively less liquid assets, in contrast with the theoretical prediction. We further exploit a period characterized by a prolonged aggregate liquidity shock on the Mexican banking system to shed light on the question: are there banks that rely more than others on liquid assets to meet their liquidity needs? We find that only small banks seem to rely on liquid assets to meet severe liquidity shocks.