Journal of Finance and Bank Management

A Model of Optimal Excess Banking Liquidity
Kouakou Thiédjé Gaudens-Omer

Abstract
This paper addresses the issue of voluntary excess bank liquidity, which is generally explained by the uncertain environment faced by risk adverse banks. We develop a model of optimal behavior of the bank, based on Baumol's (1952) optimal cash model, which shows that, whatever the degree of uncertainty, excess liquidity may appear. This is the case when expected portfolio return of the risk neutral bank is sufficiently low. The main role played by the uncertainty is to drive banks to reallocate the excess liquidity into the economy, either by increasing the proportion of loans deemed to be riskier (low uncertainty) or by increasing the proportion of safe securities (high uncertainty). An economic policy implication is that, in order to overcome the excess liquidity in countries facing a sub-financing of the economy, the solution could first consist of incentive measures that reinforce the return of bank portfolios, and then, of measures that minimize uncertainty.

Full Text: PDF     DOI: 10.15640/jfbm.v6n1a1