Liquidity rules reshape bank reserve demand rather than raise it
A Bank for International Settlements study finds that post-crisis liquidity rules and market frictions reshape central bank reserve demand rather than shifting it outward. Interbank market fragmentation breaks the direct mapping between aggregate reserve supply and money market rates.
Portfolio tradeoffs displace risky assets
The authors evaluate three assumed drivers of higher reserve demand: the Liquidity Coverage Ratio (LCR), monetization frictions, and interbank fragmentation.
Because banks can satisfy the LCR using either reserves or government bonds, the rule does not mechanically increase reserve demand.
When reserves displace higher-yielding assets, the LCR lowers reserve demand across intermediate levels and pulls the satiation point inward.
Conversely, monetization frictions for government bonds increase the insurance value of reserves during stress, flattening the demand slope and pushing the satiation point outward.
In fragmented markets, inactive banks force active lenders to absorb all payment imbalances.
Atrophy in the interbank market
Prolonged periods of abundant reserves erode interbank trading because low rate spreads discourage market participation.
As banks become inactive and rely exclusively on central bank accounts, their payment flows turn into exogenous supply shocks for the remaining active institutions.
During quantitative tightening, unexpected reductions in reserve supply force a shrinking pool of active traders to absorb the full adjustment, triggering outsized rate spikes.
The paper notes that central banks can operate lean corridor systems if transitions are pre-announced.
A regulatory alibi dismantled
Central banks can no longer cite liquidity rules to justify permanently swollen balance sheets.
The research dismantles the claim that post-crisis regulations mechanically force banks to hoard central bank cash.
Yet policymakers must still resolve the market atrophy their own floor regimes created before attempting any rapid exit.