A reallocation tactic whereby banks restructure and rebalance their portfolios toward cash reserves and more liquid investments, especially in fixed-income markets. At the same time, banks tighten their private sector credit. Lower liquidity is typically perceived to be higher risk, and vice versa. At the level of the banking system, the flight to liquidity usually triggers a systemic risk. Liquidity is a key component of systemic risk in the banking sector (and financial markets) and it reflects coordination failure. Banks rush to sell assets when they are unable to predict with a reasonable degree of certainty where the market bottom might be. This uncertainty results in the failure of implicit coordination that, in turn, causes systemic risk.
Banking
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