Liquidity Regulation and the Implementation of Monetary Policy

Morten L. Bech

Bank for International Settlements (BIS)

Todd Keister

Rutgers University

October 2013

BIS Working Paper No. 432

In addition to revamping existing rules for bank capital, Basel III introduces a new global framework for liquidity regulation. One part of this framework is the liquidity coverage ratio (LCR), which requires banks to hold sufficient high-quality liquid assets to survive a 30-day period of market stress. As monetary policy typically involves targeting the interest rate on loans of one of these assets - central bank reserves - it is important to understand how this regulation may impact the efficacy of central banks' current operational frameworks. We introduce term funding and an LCR requirement into an otherwise standard model of monetary policy implementation. Our model shows that if banks face the possibility of an LCR shortfall, then the usual link between open market operations and the overnight interest rate changes and the short end of the yield curve becomes steeper. Our results suggest that central banks may want to adjust their operational frameworks as the new regulation is implemented.

Number of Pages in PDF File: 41

Keywords: Basel III, Liquidity regulations, LCR, Reserves, Corridor system, Monetary policy

JEL Classification: E43, E52, E58, G28

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Date posted: February 27, 2014  

Suggested Citation

Bech, Morten L. and Keister, Todd, Liquidity Regulation and the Implementation of Monetary Policy (October 2013). BIS Working Paper No. 432. Available at SSRN: http://ssrn.com/abstract=2390173

Contact Information

Morten L. Bech (Contact Author)
Bank for International Settlements (BIS) ( email )
Centralbahnplatz 2
Basel, Basel-Stadt 4002
41612808923 (Phone)
Todd Keister
Rutgers University ( email )
75 Hamilton Street
New Brunswick, NJ 08901
United States
HOME PAGE: http://econweb.rutgers.edu/tkeister
Feedback to SSRN

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