The Costs and Benefits of Liquidity Regulations: Lessons from An Idle Monetary Policy Tool
46 Pages Posted: 13 Nov 2018
Date Written: November 3, 2018
We investigate how liquidity regulations affect banks by examining a disused monetary policy tool that functions as a liquidity regulation. Our identification strategy uses a regression kink design that relies on the variation in a marginal high-quality liquid asset (HQLA) requirement around an exogenous threshold. We show that mandated increases in HQLA cause banks to reduce credit supply. Liquidity requirements also depress banks' profitability, though some of the regulatory costs are passed on to liability holders. We document a prudential benefit of liquidity requirements by showing that banks subject to a higher requirement before the financial crisis have lower odds of failure.
Keywords: liquidity regulation, bank lending, monetary policy, required reserves, bank failure
JEL Classification: G21, G28, E51, E52, E58
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