Managing Regulatory Pressure: Bank Regulation and its Impact on Corporate Bond Intermediation

62 Pages Posted: 5 Jul 2023 Last revised: 10 Nov 2023

See all articles by Andreas C. Rapp

Andreas C. Rapp

Board of Governors of the Federal Reserve System

Martin Waibel

Stockholm School of Economics; Swedish House of Finance

Date Written: November 10, 2023

Abstract

We study how Basel regulations impact corporate bond intermediation in the cross-section of differently regulated intermediaries. Using intra-quarter variation in the intensity of Basel requirements, we document pronounced inventory contractions when regulatory pressure rises near quarter ends. In contrast to their behavior in short-term money markets, U.S. bank dealers do not absorb regulatory selling pressure in corporate bonds. Instead, bank dealers direct their selling primarily to nonbank financial intermediaries at sizeable price concessions. In doing so, they fall back on institutional investors to offload investment-grade bonds and nonbank dealers to dispose of high-yield bonds. In the aggregate, Basel leverage regulation significantly impairs liquidity conditions in the corporate bond market, specifically in balance sheet-intensive trades in which regulatory shadow costs account for up to 20% of average transaction costs. Our findings have implications for the design of future regulation of both bank and non-bank financial intermediaries.

Keywords: Corporate Bond, Dealer, Regulation, Liquidity, Nonbank Financial Intermediation, Insurance Companies, Networks

JEL Classification: G12, G21, G22, G23, G24

Suggested Citation

Rapp, Andreas C. and Waibel, Martin, Managing Regulatory Pressure: Bank Regulation and its Impact on Corporate Bond Intermediation (November 10, 2023). Swedish House of Finance Research Paper No. 23-12, Available at SSRN: https://ssrn.com/abstract=4500131 or http://dx.doi.org/10.2139/ssrn.4500131

Andreas C. Rapp

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://https://www.federalreserve.gov/econres/andreas-c-rapp.htm

Martin Waibel (Contact Author)

Stockholm School of Economics ( email )

PO Box 6501
Stockholm, 11383
Sweden

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

HOME PAGE: http://https://martinwaibel.com

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