Have post-crisis financial reforms crimped market liquidity?

Avinash Persaud

Financial Stability Review, 2017, issue 21, 127-138

Abstract: In this article the author considers the nature of financial market liquidity and the impact on liquidity of recent regulatory initiatives, including increases in capital requirements for bank trading books. There is some evidence and much logic that higher capital in the trading book has led to a reduction in the willingness and capacity of banks to act as market makers, reducing market liquidity. In response some officials invoke a market structure view that there is a trade-off between day-to-day liquidity on the one hand and systemic resilience on the other. They then argue that a switch towards greater systemic resilience and away from day-to-day liquidity was a necessary and overdue step. There is however little evidence that we are moving along this trade-off. A more serious attention to market structure suggests that the increasing dominance of algorithmic traders, only partly related to the rise of capital on bank trading books, and increased capital requirements for insurance companies and pension funds, would inevitably lead to a downward shift in market liquidity in general. Curbs on high-frequency trading such as levies on cancelled or very short-term trades and a change in the treatment of capital requirements for long-term savings institutions could push us to a Panglossian point where banks are not only safer but there is also more liquidity.

Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:fisrev:2017:21:12

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