Bank Balance Sheet Dynamics Under a Regulatory Liquidity-Coverage-Ratio Constraint
31 Pages Posted: 15 Sep 2013
Date Written: April 10, 2012
This paper presents a dynamic model of a bank's optimal choices of imposing a binding liquidity-coverage-ratio (LCR) constraint. Our baseline balance-sheet dynamics starts with portfolio separation and no LCR constraint. Under a scenario in which regulators prohibit banks from applying securities to fulfill the LCR constraint, portfolio separation continues to hold, but deposit holdings depend on the extent to which the LCR constraint is binding. When banks are allowed to apply securities toward satisfying the constraint, portfolio separation can break down and lead to ambiguous effects on optimal dynamic loan and deposit paths. Our results indicate that under special cases in which portfolio separation holds, the LCR constraint affects bank-sheet dynamics in ways not previously recognized. As regulators move forward in implementing Basel III style LCR, it is imperative to understand the effects of the LCR constraint on bank balance-sheet dynamics.
Keywords: Liquidity-coverage-ratio (LCR), binding constraint, portfolio separation
JEL Classification: G21
Suggested Citation: Suggested Citation