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Abstract: We model a stylized banking system where banks are characterized by the amount of capital, cash reserves and their exposure to the interbank loan market as borrowers as well as lenders. A network of interbank lending is established that is used as a transmission mechanism for the failure of banks through the system. We trigger a potential banking crisis by exogenously failing a bank and investigate the spread of this failure within the banking system. We find the obvious result that the size of the bank initially failing is the dominant factor whether contagion occurs, but for the extent of its spread the characteristics of the network of interbank loans are most important. These results have implications for the regulation of banking systems that are briefly discussed, most notably that a reliance on balance sheet regulations is not sufficient but must be supplemented by considerations for the structure of financial linkages between banks. [Copyright &y& Elsevier]

Abstract: This paper investigates the relationship between financing constraints and investment–cash flow sensitivities by focusing on cash holdings of firms as the main classification variable to separate firms into financially constrained and unconstrained categories. The idea is that high cash reserves increase the ability of firms to undertake profitable investment opportunities. Our classification is based on an optimal cash model, which helps us identify the firms that deviate significantly from their target cash ratio. We conduct the analysis for an emerging market, before and during a financial crisis to test the hypothesis that the hedging role of cash is more critical in states of the world characterized by high asymmetric information and excessive costs of external finance. The results are in line with our expectations and show that constrained firms exhibit greater investment–cash flow sensitivities than unconstrained firms. Also, there is strong evidence that cash stands as an effective device for firms, mainly during the crisis period. [Copyright &y& Elsevier]

Developing countries’ reserves have increased dramatically in recent years—growing by over 60% since the Asian financial crisis. This paper explores the self-insurance motivation behind this. As a first step, it revisits the literature on international reserve demand. This paper then examines the reserve-holding trends in a sample of 65 developing countries. It seeks to answer the following: Have reserves increased across the board or have these been concentrated in a few countries? If so, does it represent a break in previous policy? At what cost? This paper concludes by briefly examining some policy implications and avenues for future research. [Copyright &y& Elsevier]