The Spillover Effect of Liquidity Transparency on Liquidity Holdings

Abstract

I study how transparency of bank liquidity affects peer banks' liquidity holdings. Specifically, I exploit the disclosure of the liquidity coverage ratio mandated for a group of large US banks. I predict and find that the disclosure reduces non-disclosing banks’ liquidity holding incentives. This happens because the disclosure mitigates banks' uncertainty about aggregate liquidity risk. Using bank business interactions to measure how much a bank learns from the disclosure, I find that non-disclosing banks that learn more cut their liquidity significantly more in response to the disclosure. In the aggregate, liquidity in the banking system declined, and systemic risk increased after the disclosure rule adoption.

Keywords: Liquidity transparency, liquidity coverage ratio disclosure, spillover effect

JEL Classification: E44, G21, G28, M41