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The implications of liquidity regulation for monetary policy implementation and the central bank balance sheet size: an empirical analysis of the euro area

Author

Listed:
  • Kedan, Danielle
  • Veghazy, Alexia Ventula

Abstract

We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation. JEL Classification: C23, E52, G28

Suggested Citation

  • Kedan, Danielle & Veghazy, Alexia Ventula, 2021. "The implications of liquidity regulation for monetary policy implementation and the central bank balance sheet size: an empirical analysis of the euro area," Working Paper Series 2515, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20212515
    Note: 2788523
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    References listed on IDEAS

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    Cited by:

    1. Aberg, Pontus & Corsi, Marco & Grossmann-Wirth, Vincent & Hudepohl, Tom & Mudde, Yvo & Rosolin, Tiziana & Schobert, Franziska, 2021. "Demand for central bank reserves and monetary policy implementation frameworks: the case of the Eurosystem," Occasional Paper Series 282, European Central Bank.
    2. Eisenschmidt, Jens & Kedan, Danielle & Schmitz, Martin, 2024. "Euro area monetary policy and TARGET balances: A trilogy," Journal of International Money and Finance, Elsevier, vol. 141(C).
    3. Eric Magnin & Nikolay Nenovsky, 2024. "Soft monetary constraint and shortage in the European sovereign debt economy," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 37(1), pages 55-80, March.
    4. Hudepohl, Tom & Malderez, Suzanne, 2024. "The use of the Eurosystem’s monetary policy instruments and its monetary policy implementation framework in 2022 and 2023," Occasional Paper Series 355, European Central Bank.
    5. repec:bdi:wptemi:misp_032_23 is not listed on IDEAS
    6. Raffaele Lenzi & Stefano Nobili & Filippo Perazzoli & Rosario Romeo, 2023. "Banks’ liquidity transformation rate: determinants and impact on lending," Mercati, infrastrutture, sistemi di pagamento (Markets, Infrastructures, Payment Systems) 32, Bank of Italy, Directorate General for Markets and Payment System.
    7. Howard Diesel & Mukelani Nkuna & Tim Olds & Daan Steenkamp, 2022. "ThecostofcomplyingwithBaselIIIliquidityregulationsforSouthAfricanbanks," Working Papers 11032, South African Reserve Bank.

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    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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