#08-03
Liquidity Production in 21st Century Banking
Philip E. Strahan, January 2008
Abstract: I consider banks’ role in providing funding liquidity (the ability to raise cash on demand) and
market liquidity (the ability to trade assets at low cost), and how these roles have evolved.
Traditional banks made illiquid loans funded with liquid deposits, thus producing funding
liquidity on the liability side of the balance sheet. Deposits are less important in 21st century
banks, but funding liquidity from lines of credit and loan commitments has become more
important. Banks also provide market liquidity as broker-dealers and traders in securities and
derivatives markets, in loan syndication and sales, and in loan securitization. Many institutions
besides banks provide market liquidity in similar ways, but banks dominate in producing funding
liquidity because of their comparative advantage in managing funding liquidity risk. This
advantage stems from the structure of bank balance sheets as well as their access to governmentguaranteed
deposits and central-bank liquidity.
Keywords: Liquidity; securitization; loan syndication.
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