Liquidity Regulation and Bank Risk Taking on the Horizon
61 Pages Posted: 2 Apr 2020 Last revised: 29 Jul 2022
Date Written: March 9, 2020
We examine how banks' liquidity requirements may affect their incentives to take risk with their remaining illiquid assets. Our simple model predicts that banks with a greater share of stable liabilities are more likely to engage in risk taking in response to tighter liquidity requirements. This prediction is borne out in syndicated-loan data for U.S. banks subject to the Liquidity Coverage Ratio (LCR). For identification, we exploit variation in long-term bank bonds held by insurance companies that are not affected by the LCR. Our results point to a trade-off between bank risk taking and ensuring funding resilience over different horizons.
Keywords: liquidity regulation, bank risk taking, insurance sector, LCR, NSFR
JEL Classification: G20, G21, G22, G28
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