Working Paper No. 707
By Sam Miller and Rhiannon Sowerbutts
Since the 2007–09 crisis, tougher bank liquidity regulation has been imposed which aims to ensure banks can survive a severe funding stress. Critics of this regulation suggest that it raises the cost of maturity transformation and reduces productive lending. In this paper we build a bank run model with a unique equilibrium where solvent banks can fail due to illiquidity. We endogenise banks’ funding costs as a function of their liquidity and show how they are negatively related, therefore offsetting some of the costs from higher liquidity requirements. We find evidence for this relationship using post-crisis data for
US banks, implying that liquidity requirements may be less costly than previously thought.
Bank liquidity and the cost of debt