The Market's Side of Liquidity: Cheaper and Longer Funding

This chapter turns from a bank's ability to deploy liquidity to a creditor's willingness to provide it. The BIS study asks whether the LCR changed what banks paid for wholesale funding, how long that funding lasted, and how much they could borrow from money-market funds. The practical judgment is that a bank can become easier to fund because regulation makes it safer, but that external confidence is not the same as permission to spend the last percentage point above an internal or regulatory floor.

A balance sheet can look resilient from inside the bank and still depend on a market decision from outside it. Money-market funds lend to banks through short-term instruments, and their managers price the risk that a bank will repay, roll over, or become forced to liquidate assets. If the LCR reduces that risk, the regulation can affect the price and structure of funding before a crisis arrives. That is the creditor-side meaning of usable liquidity: not only assets the bank could mobilize, but financing that counterparties are willing to keep supplying.

Why money-market funds reveal creditor confidence

Money-market funds, or MMFs, invest in short-term instruments and offer investors a money-like asset. They lend to governments and private borrowers, with banks representing the dominant private-sector counterparties in the BIS paper's setting. The relevant instruments include repurchase agreements, certificates of deposit, commercial paper, and asset-backed commercial paper. These claims differ in collateral, maturity, and contractual structure, which makes them useful for observing how a creditor prices different forms of bank funding.

The BIS study uses granular holdings data. Each observation identifies the creditor fund, borrowing bank, instrument type, remaining maturity, amount, and yield. The sample covers February 2011 through December 2015, before the October 2016 MMF reform changed the structure of the market. It includes 223 funds from 72 fund families lending to 28 banks. This is not a general measure of every bank liability. It is a detailed window into one important wholesale funding market where the price and term of individual claims can be compared.

The treatment variable is the pre-regulation LCR gap. For each bank, the researchers calculate the required LCR minus the bank's average realized LCR in 2011Q1–2012Q4. A larger positive gap means that the bank was further from the requirement before the rule and therefore more exposed to the new standard. The study then compares changes before and after the revised LCR rule issued in 2013Q1 for banks with larger and smaller pre-treatment gaps.

This design deliberately avoids a simple comparison between banks subject to the LCR and banks that were not. Banks covered by the rule were generally larger, and a difference in their funding costs could reflect size, business model, or creditor composition rather than liquidity regulation. Comparing exposure within the set of regulated banks makes the contrast more focused. The question is not whether a regulated large bank looks different from a small unregulated bank. It is whether the same regulatory change had a different effect on banks that started with different distances from the required ratio.

The data also let the researchers hold the creditor and instrument context unusually constant. Bank×fund fixed effects absorb stable features of a relationship, such as persistent pricing or monitoring arrangements.