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Capital and liquidity interaction in banking

Jonathan Acosta-Smith (), Guillaume Arnould, Kristoffer Milonas and Quynh-Anh Vo
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Jonathan Acosta-Smith: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 840, Bank of England working papers from Bank of England

Abstract: We study how banks’ capital level affects the extent to which they engage in liquidity transformation. We first construct a simple model to develop testable hypotheses on this link. Then we test our predictions and establish the causality using a confidential Bank of England dataset that includes arguably exogenous changes in banks’ capital requirement add-ons. We find that banks engage in less liquidity transformation when their capital increases, which suggests that capital and liquidity requirements are at least to some extent substitutes. We also find that this substitution is mostly driven by small banks. These results have interesting implications for the optimal joint calibration of capital and liquidity requirements and for the proportionality of prudential regulations.

Keywords: Banking; liquidity transformation; capital requirements and financial regulation (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2019-12-20, Revised 2020-06-22
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn and nep-mon
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