The Impact of the Liquidity Coverage Ratio (LCR) on the Implementation of Monetary Policy

Abstract

In addition to revamping existing rules for bank capital, Basel III introduces a new global framework for liquidity regulation. One part of this framework is the Liquidity Coverage Ratio (LCR), which requires banks to hold sufficient high-quality liquid assets to survive a 30-day period of market stress. As monetary policy typically involves targeting the interest rate on loans of one of these assets-central bank reserves-it is important to understand how this regulation may impact the efficacy of central banks' current operational frameworks. We extend a standard model of monetary policy implementation in a corridor system to include term funding and an LCR requirement. When banks face the possibility of an LCR shortfall, we show that it becomes more challenging for a central bank to control the overnight interest rate and that the very short end of the yield curve becomes steeper. These results suggest that central banks may want to adjust their operational frameworks as the new regulation is implemented. JEL classification: E43, E58, G28

The Implications of Liquidity Regulation for Monetary Policy Implementation and the Central Bank Balance Sheet Size: An Empirical Analysis of the Euro Area

“…Our paper contributes to the nascent literature on the interaction between regulation and monetary policy and is, to our knowledge, the first paper that empirically assesses the impact of liquidity regulation on the demand for reserves in the euro area. Our findings support the theoretical modelbased conclusions of Bech and Keister (2017) and Körding and Scheubel (2018), as well as the conceptual findings of Bindseil and Lamoot (2011) and Schmitz (2013), that the LCR regulation could have substantial implications for the implementation of monetary policy.…”

Macroprudential Policy: A Blessing or a Curse?

“…21 See more on the negative effect of LCR in Schmitz (2013), van den End & Tabbae (2012. 22 The NSFR will become a minimum standard by January 1, 2018 (see BCBS 2012), 100% of the LCR will become a minimum standard from January 1, 2019 (see BCBS 2013).…”

A Short Note on the Net Stable Funding Ratio Requirement with Endogenous Money

“…Allen et al () focus on the impact of the whole Basel III package on lending and Gobat et al () on the difficulties of compliance at the bank level. The Basel III package includes another liquidity requirement, namely the liquidity coverage ratio (LCR) regulation, which may also have unintended consequences (de Haan and van den End, , Schmitz, ; van den End and Kruidhof, ).…”