Should Basel-style liquidity requirements be set countercyclically? Evidence from a numerical analysis

Chao Huang, Fernando Moreira and Thomas W. Archibald

International Review of Financial Analysis, 2024, vol. 95, issue PB

Abstract: We develop a model to compare the changes in banks' equilibrium capital and liquidity holdings under various versions of Basel-style requirements across economic cycles. We find that banks' liquidity is countercyclical while capital buffer is procyclical. Countercyclical liquidity-holding behaviour causes a larger liquidation of loans in economic expansions. We also find that Basel-style liquidity requirements help to lower banks' loan liquidations in economic upturns, although it is of limited effectiveness in economic downturns. We thus suggest that similar to capital requirements, liquidity requirements should also be set in a countercyclical manner. Our results show that capital requirements and liquidity requirements are complements in economic upturns in terms of enhancing banking stability and obtaining social welfare. Furthermore, Basel III outperforms previous regulatory versions in enhancing bank stability and social welfare in extreme situations.

Keywords: Bank capital; Bank liquidity; Basel accords; Social welfare (search for similar items in EconPapers)
JEL-codes: G18 G21 G28 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:95:y:2024:i:pb:s1057521924004344

DOI: 10.1016/j.irfa.2024.103502

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