Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/98856 
Year of Publication: 
2014
Series/Report no.: 
Tinbergen Institute Discussion Paper No. 14-018/IV/DSF72
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
Under Basel III rules, banks become subject to a liquidity coverage ratio (LCR) from 2015 onwards, to promote short-term resilience. We investigate the effects of such liquidity regulation on bank liquid assets and liabilities. Results indicate co-integration of liquid assets and liabilities, to maintain a minimum short-term liquidity buffer. Still, microprudential regulation has not prevented an aggregate liquidity cycle characterised by a pro-cyclical pattern in the size of balance sheets and risk taking. Our error correction regressions indicate that adjustment in the liquidity ratio is balanced towards the liability side, especially when the liquidity ratio is below its long-term equilibrium. This finding contrasts established wisdom that the LCR is mainly driven by changes in liquid assets. Policy implications focus on the need to complement microprudential regulation with a macroprudential approach. This involves monitoring of aggregate liquid assets and liabilities and addressing pro-cyclical behaviour by restricting leverage.
Subjects: 
market liquidity
funding liquidity
liquidity regulation
liquidity coverage ratio
Basel III
banks
microprudential
macroprudential
co-integration
error correction models
JEL: 
E44
G21
G28
Document Type: 
Working Paper

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