The Liquidity Coverage Ratio and Corporate Liquidity Management

Abstract

This note examines the changes in the liquidity management at banks and nonbank financial firms in the United States that occurred following the proposal of the liquidity coverage ratio (LCR) requirement in 2010 and its finalization in 2014.

Liquidity Requirements, Free‐Riding, and the Implications for Financial Stability Evidence from the Early 1900s

“…As shown in Section 4, institutions not covered by rules may believe that increased holdings of liquidity on the part of covered institutions may allow them to operate with lower liquidity holdings because they can depend on the covered institutions to supply liquidity when needed. Indeed, Yankov (2020) finds some evidence that nonbank financial institutions-such as insurance companies, finance companies, asset managers, and others-decreased their liquid assets and increased their reliance on bank credit lines to manage their liquidity risks following the adoption of the LCR. This dynamic could increase the pressure on the covered institutions during a stress event and points to the importance of understanding the liquidity position of the financial system as a whole.…”

Policy experiments and financial regulation: Using laboratory methods to evaluate responses to the 2007–2009 financial crisis

“…are careful to observe that the model on which their experiment is based excludes a central bank. Nevertheless, as observed in a recent policy analysis by Yankov (2020) the liquidity requirements imposed under Basel III quite clearly have the effect of reducing the size of the interbank market, and given the reticence of banks to use central bank liquidity facilities observed above in Section 2.1, any financial crisis that creates short term liquidity deficiencies may have the consequence of inducing considerable financial stress, as the Davis et al. experiment suggests 30…”

“…3030Yankov (2020) also observes that an important effect of the elevated liquidity requirements under Basel III is to push riskier investments with higher returns to non‐bank financial institutions. In the event of a crisis, these nonbank institutions will draw on their lines of credit at banks, creating short term liquidity deficiencies.…”

Why are Banks’ Holdings of Liquid Assets So High?

“…Dependent variables are LAR− the sum of cash holdings and non-cash liquid assets, scaled by total assets; Tier 1 ratio, total Tier 1 capital scaled by risk-weighted assets; RWA-to-assets, total risk-weighted assets scaled by total assets; Loans-to-assets, and HQLA-to-assets, high quality liquid assets scaled by total assets. We estimate HQLA following Yankov (2020) and construct the liquidity coverage ratio (LCR) following Hong et al (2014). We have two groups of treated banks, sorted by size as of t-1 (2012): Largest, banks with assets in excess of $250B (in constant 2018 dollars) and Large, banks with assets between $50B and $250B.…”

“…Liquidity coverage ratio, computed as HQLA, scaled by net cash outflows. We follow Hong et al (2014) in constructing net cash outflows using the 2013 revised standards, and compute HQLA following Yankov (2020).…”