[Liquidity risk in banking has been attributed to transactions deposits and their potential to spark runs or panics. We show instead that transactions deposits help banks hedge liquidity risk from unused loan commitments. Bank stock-return volatility increases with unused commitments, but only for banks with low levels of transactions deposits. This depositlending hedge becomes more powerful during periods of tight liquidity, when nervous investors move funds into their banks. Our results reverse the standard notion of liquidity risk at banks, where runs from depositors had been seen as the cause of trouble.]

We decompose syndicated loan risk into credit, market, and liquidity risk and test how these shape syndicate structure. Commercial banks dominate relative to non-banks in loan syndicates that expose lenders to liquidity risk. This dominance is most pronounced when borrowers have high levels of credit or market risk. We then tie commercial banks’ advantage in liquidity risk to access to transactions deposits by comparing investments across banks. The results suggest that risk-management considerations matter most for participants relative to lead arrangers. Links from transactions deposits to liquidity exposure, for instance, are more than 50% larger at participants than at lead arrangers.

Liquidity risk in banking has been attributed to transactions deposits and their potential to spark runs or panics. We show instead that transactions deposits help banks hedge liquidity risk from unused loan commitments. Bank stock-return volatility increases with unused commitments, but only for banks with low levels of transactions deposits. This deposit-lending hedge becomes more powerful during periods of tight liquidity, when nervous investors move funds into their banks. Our results reverse the standard notion of liquidity risk at banks, where runs from depositors had been seen as the cause of trouble. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: [email protected], Oxford University Press.