On the Economics of Committed Liquidity Facilities
29 Pages Posted: 27 Feb 2014
Date Written: January 2014
We study the effects of the new Basel III liquidity regulations in jurisdictions with a limited supply of high-quality liquid assets. Using a model based on Bech and Keister (2013), we show how introducing a liquidity coverage ratio in such settings can have significant side effects, leading to a large liquidity premium and pushing the short-term interest rate to the floor of the central bank’s rate corridor. Adding a committed liquidity facility allows the central bank to mitigate these effects. By pricing committed liquidity appropriately, the central bank can determine either the equilibrium liquidity premium or the quantity of liquid assets held by banks, but not both. We argue that the optimal pricing arrangement will depend on local market conditions.
Keywords: Basel III, liquidity regulation, liquidity premium, liquidity coverage ratio, committed liquidity facility
JEL Classification: E43, E58, G28
Suggested Citation: Suggested Citation