Bank Balance Sheet Dynamics Under a Regulatory Liquidity-Coverage-Ratio Constraint

31 Pages Posted: 15 Sep 2013

See all articles by Lakshmi Balasubramanyan

Lakshmi Balasubramanyan

Case Western Reserve University - Weatherhead School of Management

David D. VanHoose

Baylor University - Department of Economics

Date Written: April 10, 2012

Abstract

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

Balasubramanyan, Lakshmi and VanHoose, David D., Bank Balance Sheet Dynamics Under a Regulatory Liquidity-Coverage-Ratio Constraint (April 10, 2012). FRB of Cleveland Working Paper No. 12-09. Available at SSRN: https://ssrn.com/abstract=2325629 or http://dx.doi.org/10.2139/ssrn.2325629

Lakshmi Balasubramanyan (Contact Author)

Case Western Reserve University - Weatherhead School of Management ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States

David D. VanHoose

Baylor University - Department of Economics ( email )

P.O. Box 98003
Waco, TX 76798-8003
United States

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