Regulatory Effects on Short-Term Interest Rates
51 Pages Posted: 1 Jun 2019 Last revised: 28 Aug 2020
Date Written: August 27, 20
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
Suggested Citation: Suggested Citation