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Bank Liquidity Creation, Systemic Risk, and Basel Liquidity Regulations
We find that banks subject to the Liquidity Coverage Ratio (LCR banks) create less liquidity per dollar of assets in the post-LCR period than non-LCR banks by, in part, lending less. However, we also find that LCR banks are more resilient as they contribute less to fire-sale risk, relative to non-LCR banks. We estimate the net after-tax benefits from reduced lending and fire-sale risk to be about 1.4 percent of assets in 2013:Q2-2014 for large banks. Our findings, which we show are unlikely to result from capital regulations, highlight the trade-off between lower liquidity creation and ...
Did Banks Subject to LCR Reduce Liquidity Creation?
Banks traditionally provide loans that are funded mostly by deposits and thereby create liquidity, which benefits the economy. However, since the loans are typically long-term and illiquid, whereas the deposits are short-term and liquid, this creation of liquidity entails risk for the bank because of the possibility that depositors may ?run? (that is, withdraw their deposits on short notice). To mitigate this risk, regulators implemented the liquidity coverage ratio (LCR) following the financial crisis of 2007-08, mandating banks to hold a buffer of liquid assets. A side effect ofthe ...