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Publication . Doctoral thesis . 2014

Liquidity regulation and bank behavior

Bonner, C.;
Open Access
Published: 01 Jan 2014
Publisher: CentER, Center for Economic Research
In response to the 2007-08 financial crisis, the Basel Committee on Banking Supervision proposed two liquidity standards to reinforce banks’ resilience to liquidity risks. The purpose of this thesis is to analyze the impact of liquidity regulation on bank behavior. The first of four main chapters analyzes the development of global liquidity standards, their objectives as well as their interaction with capital standards. The analysis suggests that regulating capital is associated with declining liquidity buffers. The interaction of liquidity regulation and monetary policy, the view that regulating capital also addresses liquidity risks as well as a lack of supervisory momentum were important factors hampering the harmonization of liquidity regulation. Chapter 3 takes a wide view on the impact of liquidity regulation on banks' liquidity management. The key question is whether the presence of liquidity regulation substitutes banks' incentives to hold liquid assets. The cross-country analysis suggests that most bank-specific and country-specific determinants of banks’ liquidity buffers are substituted by liquidity regulation while a bank's disclosure requirements become more important. The complementary nature of disclosure and liquidity requirements provides a strong rationale for considering them jointly in the design of regulation. Chapter 4 zooms in on one of the key questions regarding the interaction of the LCR with monetary policy transmission. The analysis shows that a liquidity requirement causes short-term and long-term interest rates as well as demand for long-term loans to increase. However, banks do not seem able to pass on the increased funding costs in the interbank market to their private sector clients. Rather, a liquidity requirement seems to decrease banks' interest margins, which might require central banks to use a representative real economy interest rate as additional target for monetary policy implementation. Chapter 5 is motivated by the European sovereign debt crisis and analyzes the impact of preferential regulatory treatment on banks’ demand for government bonds. The analysis suggests that preferential treatment in liquidity and capital regulation increases banks' demand for government bonds beyond their own risk appetite. Liquidity and capital regulation also seem to incentivize banks to substitute other bonds with government bonds. The thesis concludes with an epilogue on liquidity stress testing.
31 references, page 1 of 4

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10 Institutions in difficulties were, for instance, BNP Paribas, the German IKB or the American Home Mortgage Investment Corp.

11 Note that this was not a classic retail bank run, as described by Diamond and Dybvig (1983). Instead of cash withdrawals of retail clients, this crisis was reflected by haircut increases in repo markets.

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Doctoral thesis . 2014
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