Over the past quarter century, the U.S. has experienced a number of financial crises. At the heart of these financial crises are often issues surrounding liquidity provision by the banking sector (e.g., Acharya, Shin, and Yorulmazer 2009). For example, in the current subprime lending crisis, liquidity seemed to have dried up for an extended time period.

The practical importance of liquidity during financial crises is buttressed by financial intermediation theory, which indicates that the creation of liquidity is an important reason why banks exist. Early contributions argue that banks create liquidity by financing relatively illiquid assets such as business loans with relatively liquid liabilities such as transactions deposits (e.g., Bryant 1980, Diamond and Dybvig 1983). More recent contributions suggest that banks also create liquidity off the balance sheet through loan commitments and similar claims to liquid funds (e.g., Holmstrom and Tirole 1998, Kashyap, Rajan, and Stein 2002). The creation of liquidity makes banks fragile and susceptible to runs (e.g., Diamond and Dybvig 1983, Chari and Jagannathan 1988), and such runs can lead to financial crises via contagion effects. Such crises can affect the real economy if they rupture the creation of liquidity (e.g., Dell’Ariccia, Detragiache, and Rajan 2008).