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A New Liquidity Risk Measure for the Chilean Banking Sector

This paper introduces a new metric for central banks – and in particular for the Central Bank of Chile – to measure liquidity risk in their banking sector using the bidding behavior of commercial banks in their open market operations.

By: , and Date: June 7, 2017 Topic: Finance & Financial Regulation

This paper was published in Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 19(3), pages 26-67, December, 2016 

The objective of this work is to construct an appropriate measure of liquidity risk for Chilean banks. There are already several measures of liquidity risk in the literature, but most of these metrics are based on specific assumptions and expert opinion. In order to overcome potential problems associated with discretionary assumptions, and to exploit information available at the Central Bank of Chile, we propose a metric based on the behavior of banks in the Central Bank’s open market operations.

We calculate the liquidity indicator at an aggregate level and for a sample of banks in a period that includes the recent subprime crisis. After that, we compare our indicator with a variety of standard metrics proposed in the literature. We find that our metric reasonably captures episodes of liquidity crises and therefore can be used as a complementary tool in the assessment of systemic risks.

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