Staff Working Paper No. 665: Dealer intermediation, market liquidity and the impact of regulatory reform

Yuliya Baranova (yuliya.baranova@bankofengland.co.uk), Zijun Liu and Tamarah Shakir (tamarah.shakir@bankofengland.co.uk)
Additional contact information
Yuliya Baranova: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Tamarah Shakir: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 665, Bank of England working papers from Bank of England

Abstract: We develop a model of dealer intermediation in bond markets that takes account of how changing regulatory requirements for banks since the financial crisis, in particular, the introduction of minimum leverage ratio requirements, affect the cost and ability of dealer banks to provide intermediation services. The framework considers two distinct dealer functions: that of provider of repo financing (to prospective bond market participants) and that of market-maker. The cost and ability of dealers to provide these services under different regulatory constraints determines the price impact of a given trade on the market — or the level of ‘market liquidity premia’. In the model the impact on market liquidity varies for different levels of market volatility or ‘stress’. We find that under normal market conditions estimates of corporate bond liquidity risk premia are higher under the new regulations, but also that corporate bond market liquidity is more resilient due to better-capitalised dealers continuing to intermediate markets under higher levels of market stress than pre-crisis. Mapping these changes in liquidity premia to GDP, via their impact on the cost of borrowing for corporates in the real economy, the results of the model suggest that under normal market conditions there may be a greater cost of regulation via corporate bond markets than incorporated in earlier studies. However, once offset against the benefits of greater dealer resilience, including the benefits to market functioning, there remain net benefits to new regulations.

Keywords: Regulation; market liquidity; dealer intermediation; corporate bonds; cost-benefit analysis (search for similar items in EconPapers)
JEL-codes: G12 G23 G24 G29 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2017-07-14
New Economics Papers: this item is included in nep-ban and nep-mst
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Citations: View citations in EconPapers (12)

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