The impact of liquidity constraints on bank lending policy

This paper examines banks' provision of liquidity to depositors and piovisi on of loans. The problem identified is that banks may not be able to provid e new funds for borrowers who are short of cash, because either the return on investments is poor, or because depositors withdraw more funds than expe cted. Banks subject to liquidity shortages may ration loans to good borrowe rs. This problem is shown to depend upon the nature of the deposit contract and banks' inability to issue subordinated deposits. State contingent rene gotiation of loans and matching of the duration of project returns and inve stment needs mitigates the problem.