LCR regulation lowers bank funding costs, especially for long-term debt
A new Bank for International Settlements (BIS) working paper establishes a causal link between liquidity regulation and lower bank wholesale funding costs. It finds that banks with greater LCR exposure see a steeper decline in funding costs, especially for longer-maturity instruments.
Unpacking the LCR's impact
The study establishes a causal link between liquidity regulation and lower bank wholesale funding costs.
Using pre-determined variation in banks' Liquidity Coverage Ratio (LCR) exposure and granular instrument-level data from U.S. money market funds, the researchers identify a significant reduction in borrowing costs.
Banks with larger pre-regulation LCR gaps experienced a steeper decline in wholesale funding costs after the LCR's introduction in 2013Q1. A one-standard-deviation increase in the LCR gap is associated with an approximately 8 percent reduction in funding costs, translating to about 2.5 basis points.
This effect is more pronounced for longer-maturity instruments, with rate declines twice as large for those over 30 days compared to one-day maturities.
The paper also documents a shift in bank borrowing towards longer-term liabilities.
Beyond aggregate data
Theoretically, liquidity regulation should lower bank wholesale funding costs by increasing resilience and reducing risk premia, particularly for longer-maturity instruments.
It should also encourage a shift from short-term debt to longer maturities.
However, obtaining causal evidence has been challenging due to regulation being introduced as a package and limitations of aggregate funding cost data.
This paper overcomes these difficulties by using granular, instrument-level data on U.S. banks' borrowing from money market funds.
This allows for careful control of time-varying factors at the creditor, instrument type, and macroeconomic levels, providing robust identification of the LCR's specific effects.
Regulation's hidden benefit
This paper offers crucial empirical backing for a central premise of bank regulation.
It demonstrates that prudential rules, specifically the LCR, can yield tangible benefits through reduced funding costs, partially offsetting compliance burdens.
The robust causal evidence provides a strong foundation for future policy discussions on liquidity frameworks.
Source: Liquidity regulation and bank funding costs
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