Liquidity Regulation and Bank Funding Costs

Abstract

Using granular instrument-level data, we establish a causal link between liquidity regulation and a lower cost of bank wholesale funding. For identification, we leverage pre-determined variation in banks' exposure to the liquidity coverage ratio (LCR) in a difference-in-differences setup. Granular data allow us to carefully control for any observable and unobservable time-varying factors at the creditor, instrument type, and macroeconomic levels. We find that banks with greater LCR exposure see a steeper decline in their wholesale funding costs. Consistent with seminal theoretical papers on bank liquidity risk, we provide novel evidence that wholesale funding costs decline by more for longer-maturity instruments; and that banks shift from shorter into longer-maturity liabilities. Our results support the argument that bank regulation can - at least partly - offset its costs to intermediaries through lower funding costs.

Keywords: bank regulation, Basel III, money market funds, market discipline, liquidity risk, Liquidity Coverage Ratio

JEL Classification: G28