We examine how the banking sector may ignite the formation of asset price bubbles when there is access to abundant … liquidity. Inside banks, given lack of observability of effort, loan officers (or risk takers) are compensated based on the … macroeconomic risk, investors reduce direct investment and hold more bank deposits. This ‘flight to quality’ leaves banks flush with …

asset price bubbles in the economy. To curb such risk-taking incentives at banks and the resulting asset bubbles, Central …When liquidity chasing banks is high, loan officers (or risk-takers) inside banks expect future losses to be readily …