July 13, 2018

ECB published a working paper that investigates the costs and benefits of liquidity regulation. The authors find that liquidity tools are beneficial but cannot completely remove the need for Lender of Last Resort (LOLR) interventions by the central bank.

The paper investigated the extent to which the two main liquidity ratios (Liquidity Coverage Ratio, or LCR, and the Net Stable Funding Ratio, or NSFR) might have been effective in reducing liquidity take-up by European banks during the post-Lehman crisis as well as the European Sovereign Debt crisis. It was found that full compliance with the current LCR and NSFR rules would have reduced banks’ reliance on publicly provided liquidity during the global financial crisis, without removing such assistance altogether. Nevertheless, the evidence also suggested that liquidity regulations (at least as currently specified) would not have prevented the need for large public liquidity assistance for European banks. The empirical results, therefore, pointed to caution against expecting the end of LOLR interventions due to the application of the current liquidity policy tools. 

The authors estimated the cost for banks of complying with the LCR and NSFR and found that these costs turn out to be non-trivial but small, especially when compared with the costs of capital requirements. When the introduction of the LCR and NSFR was simulated in two structural macro-financial models, it was found that the regulations would lead to relatively modest declines in lending and real activity. The analysis, therefore, suggested that while the LCR and NSFR do not have financial stability benefits on a par with bank capital requirements, they are still useful due to their relatively low cost. 

 

Related Link: Working Paper (PDF)

Keywords: Europe, EU, Banking, Liquidity Risk, LCR, NSFR, Basel III, ECB

 

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