Liquidity Risk and Deposit Contracts in Banking

This lecture covers the critical aspects of liquidity risk and deposit contracts in banking. It begins with a review of interest rate risk, emphasizing the earnings and economic value perspectives. The instructor discusses the regulatory requirements for banks to disclose their interest rate risk exposure, particularly under Basel III standards, and highlights the differences in disclosure practices between countries. The lecture then transitions to liquidity risk, explaining its significance and the unique features of deposit contracts, such as availability on demand and sequential service constraints. The instructor elaborates on the theories of market discipline and liquidity insurance, illustrating how these concepts relate to the behavior of depositors during bank runs. The discussion includes empirical evidence from recent banking crises, particularly the collapse of Silicon Valley Bank, and the role of deposit insurance in mitigating liquidity risk. Finally, the lecture concludes with an overview of wholesale funding and the regulatory metrics used to assess liquidity risk in banks.