Surviving Liquidity Shocks: Insights and Lessons from The Recent Banking Crises

Abstract

Financial institutions worldwide still face liquidity shocks through rapid deposit outflows, wholesale funding scarcity, and failure of interbank lending. Banking crises in recent years have highlighted that vulnerabilities are still left to be resolved, even just after the reforms that came post-2008, particularly during accelerated market conditions. This review studies the critical mechanisms that generate liquidity stress and the channels through which liquidity stress can propagate, discusses empirical findings from recent episodes of liquidity stress, and comments on the efficacy of the risk management tools used by supervisors and the policy responses that were taken. In addition, the paper presents a theoretical framework for multi-layered liquidity defense and suggests directions for further research in stress testing, digital banking risks, regulatory design, and as well as behavioral triggers for liquidity events. The goal is to advise a more shock-resilient financial system that absorbs liquidity shocks without destabilizing the financial system as a whole.