From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity?
86 Pages Posted: 16 Jun 2019 Last revised: 17 Oct 2019
Date Written: September 25, 2019
Post-crisis bank regulations raised the market-making costs of bank-affiliated dealers. We show that this can, somewhat surprisingly, improve the overall welfare of investors and reduce average transaction costs, despite the increased cost of immediacy. Bank dealers in OTC markets optimize between two parallel trading mechanisms: market making and matchmaking. Bank regulations that increase market-making costs intensify competitive pressure from non-bank dealers and incentivize bank dealers to invest in technology that shifts their business toward matchmaking. Thus, post-crisis bank regulations have the (unintended) benefit of replacing the costly balance sheet of banks with a more efficient form of financial intermediation.
Keywords: bank regulation, financial crisis, corporate bonds, liquidity, over-the-counter markets, broker-dealers, Basel 2.5, Basel III, Volcker Rule, post-crisis regulation, market making, matchmaking
JEL Classification: G01, G12, G21, G24, G28
Suggested Citation: Suggested Citation