Evaluating the effect of banks' liquidity shock on the excess reserves and business cycles in Iran with the DSGE model

Introduction: The purpose of this paper is to investigate the impact of banks' liquidity shock on their excess reserves and the business cycles in Iran's economy. In order to benefit from the functional tasks of the banking system in the real sector of the economy, it is necessary to control the liquidity in the hands of the bank. The liquidity management by the bank includes predicting liquidity needs and providing them at the lowest possible cost. The main reason for the liquidity risk is that most bank resources are provided from short-term deposits, while the bank facilities are used to invest in assets that have a relatively low degree of liquidity. Therefore, a main task of the bank should be creating a balance between short-term financial obligations and long-term investments. Maintaining insufficient amounts of liquidity exposes the bank to the risk of not being able to fulfill its obligations and pushes it toward bankruptcy. Also, maintaining large amounts of liquidity causes inefficient allocation of resources, reduction of the interest rate on deposits and, as a result, losing the market.
Methodology: In order to analyze the results, the dynamic stochastic general equilibrium method was used in terms of the structure of the banking system in the period of 1989-2020 based on the frequency of the seasonal data. In the statistical analysis section, the impacts of the impulse from liquidity on the surplus bank reserves, business cycles, and a set of banking and macroeconomic variables were compared and evaluated. The current research model has five parts including household sectors, producers of intermediate goods and final goods, banking sector, government and central bank. The household sector maximizes the expected discounted utility function with respect to the inter-period budget constraint. Intermediary companies seek to minimize the production cost function, and the company producing the final product deals with pricing based on Rotenberg's price stickiness theory. In order to maximize the expected profit function, the banking sector makes its decisions to determine the optimal interest rates of deposits and facilities for both households and companies. It should be mentioned that regarding bank rates for deposits and facilities, although the range of interest rates for deposits and facilities is communicated to the banks, the banks act based on other variables. They have the option to consider the maximum expected profit function based on their requirements, such as the amount of the fixed balance in the customer's account of facility reception or the interest paid to depositors. Finally, the government and the central bank are face with an inter-period budget constraint.
Results and Discussion: Based on the obtained results, the momentum of liquidity induced by the banking system has led to an increase in their surplus reserves and the occurrence of business cycles and deviations in production. Also, the liquidity shock has led to an increase in the inflation rate and exchange rate in the economy. It is recommended to eliminate the effect of liquidity shocks of the banking system on the economy by using precautionary and unconventional policies. In order to improve the relationship between the Central Bank and the banks, managing the overdrafts of the banks from the Central Bank by guaranteeing the overdrafts and regular financing is an important and fundamental task in the agenda of the Central Bank. The intelligent monitoring of the facilities and transactions in the banking network by the Central Bank can correct the asset and capital structure of banks, improve the risk management system, transparency of financial reporting in banks, organize the non-banking activities of banks and their subsidiaries, and prevent the entry of resources into speculative activities. Also, selling the surplus assets of banks is considered as an important act to reform the functioning of the banking system.
Conclusion: The liquidity shock from the banking system has led to an increase in their excess reserves, the emergence of business cycles and fluctuations in production, and increased inflation rate and exchange rate in the economy. Based on the results, it is recommended to prevent liquidity shocks from the banking system by using conservative and unconventional policies. Since an important part of creating liquidity in the country's economy has been done by banks in the past years, controlling the creation of money and liquidity by banks can play an important role in reducing the growth of liquidity and inflation. Therefore, there is a need for structural reforms and the supervision of the banking system. According to the proposed economic theories and the results obtained from this study, if a change is made in the credit risk, liquidity of commercial banks in money creation, and therefore the profit margin of the banks, monetary policy may be able to directly influence the interest rate in the credit market. In this case, an asymmetry may arise. An increase in the policy-based interest rate always leads to an increase in the interest rate in the credit market because commercial banks have to compensate the costs of re-borrowing and have to earn at least a profit. But if the liquidity risk and credit risk of commercial banks increase due to increased uncertainty, or if the level of banks' requested interest increases, a reduction in the base rate may not be immediately accompanied by a reduction in the credit market rate.