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The Effects of Liquidity Regulation on Bank Assets and Liabilities

Author

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  • Patty Duijm

    (Duisenberg School of Finance, De Nederlandsche Bank, Amsterdam, the Netherlands)

  • Peter Wierts

    (De Nederlandsche Bank, Amsterdam, the Netherlands)

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.

Suggested Citation

  • Patty Duijm & Peter Wierts, 2014. "The Effects of Liquidity Regulation on Bank Assets and Liabilities," Tinbergen Institute Discussion Papers 14-018/IV/DSF72, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20140018
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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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