Focus
Following the financial crisis of 2008–09, the Basel Committee on Banking Supervision introduced global liquidity standards to mitigate the liquidity risks arising from funding illiquid assets with short-term liabilities. In the United States, these standards resulted in the introduction of the Liquidity Coverage Ratio (LCR) requirement for large banks. The onset of liquidity regulation coincided with a dramatic increase in private credit, originated directly by non-banks and held on the balance sheets of private credit funds and business development companies. In this paper, we study the extent to which liquidity requirements contributed to the growth of private credit, a market that has grown rapidly in recent decades and has become a major source of funding for various types of firms.
Contribution
We contribute to the understanding of the drivers of private credit. Low interest rates and reach for yield as well as bank capital regulation are often-cited macro drivers. Our findings also add to earlier evidence that liquidity regulation has crowded out some lending by affected banks and spurred a shift towards smaller, less regulated banks.
Findings
We find that, following the introduction of the LCR, private credit increases significantly more in US counties with a larger footprint of banks subject to the LCR or of LCR banks with greater initial liquidity shortfalls. The economic magnitude of the estimated effect is large. A one standard deviation higher ex ante footprint of LCR banks in the county results in nearly 50% higher private credit volumes following the introduction of the LCR. Moreover, our estimated effect of the LCR on private credit growth is comparable in economic magnitude with that of the increased capital requirements from the 2012 Comprehensive Capital Analysis and Review (CCAR) stress tests. While the shift in lending from deposit-financed banks to private credit funds could imply a substantial drop in overall liquidity risk, total systemic risk effects are complex, and assessing them is beyond the scope of the paper.
Abstract
We study the role of bank liquidity regulation in the growth of private credit. Following the introduction of the liquidity coverage ratio (LCR), private credit increases significantly more in U.S. counties with a larger footprint of banks subject to the LCR or of LCR banks with greater initial liquidity shortfalls. Our estimated effect of the LCR on private credit growth is comparable in economic magnitude to that of the increased capital requirements from the 2012 CCAR stress tests. Consistent with loan supply effects, the relationship between banks’ LCR footprint and private credit is stronger in industries that are more reliant on credit.
