Liquidity Regulation and Financial Intermediaries

Marco Macchiavelli and Luke Pettit

Journal of Financial and Quantitative Analysis, 2021, vol. 56, issue 6, 2237-2271

Abstract: The liquidity-coverage ratio (LCR) requires banks to hold enough liquidity to withstand a 30-day run. We study the effects of the LCR on broker-dealers, the financial intermediaries at the epicenter of the 2007–2009 crisis. The LCR brings some financial-stability benefits, including a significant maturity extension of triparty repos backed by lower-quality collateral, as well as the accumulation of larger liquidity pools. However, it also leads to less liquidity transformation by broker-dealers. We also discuss the liquidity risks not addressed by the LCR. Finally, we show that a major source of fire-sale risk was self-corrected before the introduction of postcrisis regulations.

Date: 2021
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