Regulatory Effects on Short-Term Interest Rates

Abstract

We analyse the effects of prudential regulation on short-term interest rates. The European Market Infrastructure Regulation (EMIR) induces clearing houses (CCPs) to supply large amounts of cash in reverse repurchase agreements (repos). Basel III, in contrast, disincentivises the borrowing demand by tightening banks' balance sheet constraints. Using unique regulatory data of CCP investment activity and repo transactions, we find compelling evidence for both supply and demand channels. The overall effects are decreasing short-term rates and increasing market imbalances in various forms, all of which entail unintended consequences originated from the new regulatory framework.

Keywords: Interest rates, repo, central clearing, financial infrastructure, leverage ratio, EMIR, regulatory effects, safe assets, collateral

JEL Classification: G28