Working Paper: CEPR ID: DP16438
Authors: Joshua Bosshardt; Ali Kakhbod; Farzad Saidi
Abstract: We examine the system-wide effects of liquidity regulation on banks' balance sheets. In the general equilibrium model, banks have to hold liquid assets, and choose among illiquid assets varying in the extent to which they are difficult to value before maturity, e.g., structured securities. By improving the liquidity of interbank markets, tighter liquidity requirements induce banks to invest in such complex assets. We evaluate the welfare properties of combining liquidity regulation with other financial-stability policies, and show that it can complement ex-ante policies, such as asset-specific taxes, whereas it can undermine the benefits of ex-post interventions, such as quantitative easing.
Keywords: liquidity regulation; securitization; interbank markets; financial stability; quantitative easing
JEL Codes: E44; G01; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tighter liquidity requirements (G28) | banks invest in complex assets (G21) |
| liquidity regulation (G28) | banks' investment behavior (G21) |
| liquidity regulation (G28) | financial stability implications (F65) |
| investment in complex assets (E22) | destabilizing effects on financial system (F65) |
| tighter liquidity regulation (G28) | dampen positive effects of quantitative easing (E52) |
| liquidity regulation + asset-specific taxes (F38) | complement banks' investment (O16) |
| liquidity regulation + quantitative easing (E59) | undermine benefits (J32) |