Liquidity Mismatch and Bank Runs, explained.
Liquidity mismatch arises when short-notice liabilities fund assets that cannot be converted to cash quickly at their full longer-term value.
Why it happens
Fifty unit deposits fund cash and a long asset returning 1.5 at maturity but 0.5 under early liquidation. Early requests trigger liquidation, and the remaining balance sheet determines later assets per unpaid claim.
Liquidity mismatch arises when short-notice liabilities fund assets that cannot be converted to cash quickly at their full longer-term value.
Read the result
Unpaid early claims remain among remaining claims. Maturity assets reflect any long holdings destroyed by early liquidation, not their original eventual payoff.
A worked example
Meet early claims by selling long assets cheaply
Choose reserves ten and early withdrawals ten, leaving the long asset intact.
Set early requests thirty and settle, requiring liquidation of all forty long-asset units at one-half each.
Compare maturity assets per remaining claim with the first scenario, keeping strategic run beliefs outside this balance-sheet exercise.
OPTIONAL DEEPER DETAILGo deeper: inside the model
Inside this model
Fifty unit deposits fund cash and a long asset returning 1.5 at maturity but 0.5 under early liquidation. Early requests trigger liquidation, and the remaining balance sheet determines later assets per unpaid claim.
Where this idea is useful
A practical use
Separate an asset’s eventual payoff from the cash available to meet immediate withdrawals.
A common misconception
“An asset with a positive eventual payoff can always meet immediate liabilities at that value.”
Timing and liquidation discounts matter: an asset’s maturity value does not necessarily provide enough cash for short-notice withdrawals.
What this explanation leaves out
- This balance-sheet scenario omits strategic beliefs, insurance, central-bank support and actual institutions. It is neither a full Diamond–Dybvig equilibrium nor a solvency forecast.
Does this scenario identify which real bank will fail?
No. It omits actual balance sheets, insurance, central-bank access and strategic beliefs, so it cannot assess an institution’s solvency.
What value is lost when a long asset must fund a claim earlier than planned?
Associated thinkers
Associations marked provisional are awaiting source review.
Further reading
Explore the original research or the teaching reference behind this experiment.