Modelling the liquidity ratio as macroprudential instrument
The Basel 3 Liquidity Coverage Ratio (LCR) is a micro prudential 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 which 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 last resort has to underpin the stability of the system.
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- Claudio Borio & Mathias Drehmann, 2011.
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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.
- Claudio Borio & Claudio Mathias Drehmann, 2009. "Towards an operational framework for financial stability: "fuzzy" measurement and its consequences," BIS Working Papers 284, Bank for International Settlements.
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