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The implications of liquidity regulation for monetary policy implementation and the central bank balance sheet size: an empirical analysis of the euro area

Danielle Kedan and Alexia Ventula Veghazy

No 2515, Working Paper Series from European Central Bank

Abstract: We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation. JEL Classification: C23, E52, G28

Keywords: Basel III; central bank operational framework; ECB; liquidity coverage ratio; monetary policy (search for similar items in EconPapers)
Date: 2021-01
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-mac and nep-mon
Note: 2788523
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