LCR buffers enable banks to maintain credit during stress
A Federal Reserve working paper shows that banks with higher regulatory liquidity buffers provided significantly more credit during the March 2020 COVID-19 stress. The study reveals that buffers, rather than absolute liquidity levels, determine lending capacity.
Beyond the regulatory minimum
Analyzing confidential bank-firm credit data and hand-collected Liquidity Coverage Ratio disclosures, the paper examines bank lending during the acute phase of the COVID-19 crisis in March 2020.
The authors find that banks with higher LCR buffers above the regulatory minimum provided 10.5 percent more credit to exposed firms with large undrawn credit lines.
Critically, absolute LCR levels do not drive this lending support, demonstrating that regulatory minimums operate as binding constraints during market stress.
This confirms the theoretical last taxi problem where institutions hoard liquidity to avoid breaching floors.
Targeted support for prime borrowers
The liquidity support proved both temporary and highly selective.
The credit differential disappeared entirely by the second quarter of 2020 as acute market stress subsided.
Furthermore, the additional lending concentrated exclusively among prime corporate borrowers with high undrawn capacity and clean credit profiles, while firms facing binding financial covenants received no extra credit support from high-buffer lenders.
Regulatory illusion or real safety?
The study exposes a critical vulnerability in post-crisis banking rules.
Liquidity requirements designed to prevent runs ironically paralyze lenders when they are needed most.
Regulators must urgently rethink how buffers function during systemic stress.