DP9124 The Impact of Liquidity Regulation on Interbank Money Markets

Author(s): Clemens Bonner , Sylvester C W Eijffinger

Publication Date: September 2012

Date Revised: March 2012

Keyword(s): Basel 3 , Interbank Market , monetary policy , liquidity

JEL(s): E42 , G18 , G21

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP9124.asp.asp

This paper analyzes the impact of a liquidity requirement similar to the Basel III Liquidity Coverage Ratio (LCR) on the interbank money market and monetary policy implementation. By combining two unique datasets of Dutch banks from 2004 to 2011, we show that non-compliance with a liquidity requirement causes banks to pay and charge higher interest rates for loans with maturities longer than the requirement’s 30 day horizon. With respect to volumes, our analysis reveals that banks with a liquidity deficiency increase borrowing and decrease lending of long-term loans. Short-term loans seem to be unaffected by a liquidity requirement. A key takeaway from our analysis is that as long as only a small share of banks is non-compliant with the liquidity requirement, monetary policy implementation is likely to be unaffected. As soon as there is an aggregate shortage, central banks should consider using the interbank term rate as (additional) target for monetary policy implementation.