The Liquidity Coverage Ratio a Decade On: A Stocktake of the Literature

In the decade since the implementation of the Liquidity Coverage Ratio (LCR), what have we learned about its design, effectiveness, and impact? The LCR is a central pillar of the Basel III regulatory reforms and aims to ensure that banks hold sufficient high-quality liquid assets to withstand short-term funding stress. Theoretical work, which mostly features fire-sale externalities, concludes that the LCR can raise welfare by mandating banks to hold more liquid assets or rely less on fragile short-term funding. Empirical work suggests that the LCR strongly raises banks' high-quality liquid assets and somewhat reduces their reliance on short-term funding. However, it can crowd out lending and induce greater risk-taking. The survey concludes with a discussion of open questions about the LCR's calibration, consequences, and interaction with central bank policies.