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Modelling the liquidity ratio as macroprudential instrument

Listed author(s):
  • Jan Willem van den End
  • Mark Kruidhof

The Basel III Liquidity Coverage Ratio (LCR) is a microprudential instrument to strengthen the liquidity position of banks. However, if in extreme scenarios the LCR becomes a binding constraint, the interaction of bank behaviour with the regulatory rule can have negative externalities. We simulate the systemic implications of the LCR by a liquidity stress-testing model, which takes into account the impact of bank reactions on second round feedback effects. We show that a flexible approach of the LCR, in particular one that recognises less liquid assets in the buffer, is a useful macroprudential instrument to mitigate its adverse side effects during times of stress. At extreme stress levels the instrument becomes ineffective and the lender of the last resort has to underpin the stability of the system.

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Article provided by Palgrave Macmillan in its journal Journal of Banking Regulation.

Volume (Year): 14 (2013)
Issue (Month): 2 (April)
Pages: 91-106

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Handle: RePEc:pal:jbkreg:v:14:y:2013:i:2:p:91-106
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Order Information: Web: http://www.springer.com/finance/journal/41261/PS2

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  1. Claudio Borio & Mathias Drehmann, 2011. "Toward an Operational Framework for Financial Stability: “Fuzzy” Measurement and Its Consequences," Central Banking, Analysis, and Economic Policies Book Series,in: Rodrigo Alfaro (ed.), Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 4, pages 063-123 Central Bank of Chile.
  2. Jan Willem van den End, 2012. "Liquidity stress-tester: do Basel III and unconventional monetary policy work?," Applied Financial Economics, Taylor & Francis Journals, vol. 22(15), pages 1233-1257, August.
  3. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
  4. Acharya, Viral & Song Shin, Hyun & Yorulmazer, Tanju, 2009. "Endogenous choice of bank liquidity: the role of fire sales," Bank of England working papers 376, Bank of England.
  5. Tapking, Jens & Eisenschmidt, Jens, 2009. "Liquidity risk premia in unsecured interbank money markets," Working Paper Series 1025, European Central Bank.
  6. Viral V. Acharya & Denis Gromb & Tanju Yorulmazer, 2012. "Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(2), pages 184-217, April.
  7. Harry Zheng, 2008. "Jump liquidity risk and its impact on CVaR," Journal of Risk Finance, Emerald Group Publishing, vol. 9(5), pages 477-492, November.
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