Karen Petrou: Making Liquidity Regulation Make Sense
Although U.S. regulators remain determined to enact each rule as if it relates to no other, researchers have increasingly found that rules have cumulative and often conflicting purposes – see, for example, the sum total of bank rules which empowered nonbank financial intermediaries operating with impunity until they needed trillions in taxpayer backstops in 2020. Following a seminal Federal Reserve Bank of New York paper on the cumulative consequences – none good – of considering capital and liquidity rules in isolation, a new BIS paper considers the internal contradictions of consequential liquidity regulation and central-bank backstops. Now, if only bank regulators at home and abroad did the same.
The BIS paper looks at the push-pull evident in liquidity rules founded on expectations that banks should not use central-bank liquidity even though central banking is founded on the concept of providing liquidity to banks under stress. As all too evident in the 2023 crisis, liquidity compliance cannot ensure banks stand firm in a run, even as the Fed’s discount window opened with all the alacrity of an centuries-old casement. Solutions posed ever since have suggested stiffening the liquidity standards and ensuring discount-window operability, but each thread of this debate ignores the other. The BIS paper happily proposes a framework in which the two pillars of bank resilience under liquidity stress are considered together to craft a sensible benign-scenario liquidity rule along with an effective, disciplined backstop that minimizes moral hazard.
The BIS paper rightly is to avoid so stringent a build-up …