Benoît Coeuré: Liquidity regulation and monetary policy implementation -
from theory to practice
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,
at the Toulouse School of Economics, Toulouse, 3 October 2013.
* * *
I wish to thank Conception Alonso and Stefano Corradin for their contributions to these remarks. I remain solely
responsible for the opinions contained herein.
Ladies and Gentlemen,
It is a great pleasure for me to speak at the Toulouse School of Economics.
In my remarks today, I would like to discuss the recent developments on liquidity regulation
and the interplay between the new liquidity requirements and monetary policy
implementation.
The recent financial crisis provided a vivid illustration of how liquidity risk that materialises in
some segments of the financial system can lead to the drying-up of liquidity in entire market
segments, such as unsecured interbank markets, causing a system-wide scramble for
liquidity. In that context, central banks have played a role of intermediary for interbank
transactions and prevented our bank based financial system from collapsing.
At the beginning of my remarks, I will talk about the rationale for liquidity regulation and I will
provide an overview of the new set of liquidity requirements that the Basel Committee on
Banking Supervision has proposed to complement its revised capital requirements
framework.
These recent developments give rise to two issues that I would like to address today. First,
how do liquidity regulation and monetary policy implementation interact? I will argue that the
new set of liquidity requirements is expected to have an impact on how monetary policy is
implemented in normal times. It is important to understand how this new requirement may
impact the current operational framework, especially for the Eurosystem, and the functioning
of money markets.
The second issue regards lending of last resort. It is commonly accepted that central banks
have to act as lenders of last resort (LOLR) towards banks during a crisis period, when
liquidity can dry up. But it is also well known that such intervention can generate moral
hazard in the banking system, lead central banks to take unwarranted credit risk and, in
some extreme cases, interfere with their primary mandate - price stability.
Are the new liquidity ratios, in combination with the revised capital ratios, sufficient to prevent
the central bank from becoming the lender of first resort? Based on recent academic
research, to which researchers of this university have significantly contributed, I will argue
that liquidity regulation can ensure that central bank intervention remains exceptional, and be
designed in a way that is compatible with sound incentives in the banking system.
Rationale for liquidity regulation
I would like to begin by briefly highlighting the micro- and macro-prudential benefits that will
derive from a new set of liquidity standards. In particular, they should lead to an increase in
individual credit institutions' liquidity buffers, and reduce the risks posed by maturity
transformation.
The recent financial crisis provided a dramatic illustration of how liquidity risk materialises.
The inadequacies of banks' liquidity management became apparent when some markets for
long-term debt securities (including ABS, ABS CDOs, etc.) experienced a sudden re-pricing,
resulting from the fact that risks were not properly reflected in their prices. Banks faced
substantial liquidity outflows and shortages owing to their excessive exposure to these
instruments and their excessive reliance on short-term and volatile secured market funding
sources. In the US, this phenomenon mainly materialised as a "run on repo";1 in the euro
area, it resulted into drying up of foreign currency funding, severe strains in bank unsecured
funding, and/or a reduced access to repo through clearing houses. In all cases, the central
bank had to step in and to expand its liquidity provision to banks.
What does this imply for liquidity regulation? Regulations should start from first principles,
and we therefore have to identify the market failures or negative externalities that liquidity
regulation aims at addressing.
I consider that there are three main objectives for liquidity regulation: a) to reduce the impact
of uncertainty on the bank risk profile, b) to build up liquidity buffers and c) to mitigate the
systemic characteristics of a liquidity crisis.
Maturity transformation gives rise to liquidity risk since, by definition, a bank engaging in
maturity transformation cannot honour sudden and large withdrawal requests by depositors.
They may face similar difficulties if interbank market lenders refuse to roll over their loans.
Such coordination failure may arise not because the depositors or the interbank market
participants think the bank is likely to be insolvent, but because they anticipate others will
withdraw.2 The rationale of liquidity requirements is that they reduce the impact of uncertainty
on the bank risk profile, since they allow the bank to withstand larger withdrawals. LOLR and
deposit insurance are other ways to achieve the same means: mitigating the risk of a run.
The difference is that liquidity requirements are internalised, while LOLR and deposit
insurance are externalised to the central bank and to the taxpayers, respectively. Another
difference is that liquidity requirements and deposit insurance exert their effects ex ante while
LOLR happens after the fact.
An additional micro-prudential benefit derived from liquidity requirements relates to a special
role of liquid assets. By maintaining liquidity buffers in advance, banks commit to removing
solvency risk from a portion of their portfolio. This limits solvency risk and encourages good
risk management, acting as a prudential regulatory tool alongside other requirements, such
as capital buffers or bail-inable debt, that also exert discipline on bank risk-taking behaviour.3
A counterargument is however that holding a large balance of liquid assets gives bank
management too much discretion and can thus create agency problems.4
Liquidity standards should also be designed to mitigate adverse effects owing to inherently
systemic characteristics of a liquidity crisis. The reaction of one bank to liquidity strains might
create major liquidity strains for other banks. This may indeed require liquidation of long-term
and illiquid assets, imposing externalities on other banks through a fire sales spiral and
various forms of financial contagion. In addition, the failure of a bank that occupies a critical
size or position in a market could have immediate systemic implications: some segments of
financial markets might just cease to operate, and its disorderly collapse would lead to
1
Gorton and Metrick (2012) document a full-scale "run" on repo; see G. Gorton and A. Metrick, "Securitised
banking and the run on repo", Journal of Financial Economics, forthcoming. However, Krishnamurthy et al.
(2012) document that a "run" on repo didn't seem to have occurred in some repo segments; see
A. Krishnamurthy, S. Nagel and D. Orlov, "Sizing up repo", NBER Working Paper No. 17768, 2012.
2
As in D. Diamond and P. Dybvig, "Bank runs, deposit insurance, and liquidity", Journal of Political Economy
91, 1983.
3
Calomiris, Heider, and Hoerova (2013) highlight the potential benefits of bank liquidity requirements in
comparison with capital; see. C. Calomiris, F. Heider and M. Hoerova, "A theory of bank liquidity
requirements", mimeo, European Central Bank, 2013.
4
See S. Myers and R. Rajan (1998), "The paradox of liquidity", Quarterly Journal of Economics, Vol. 113,
pp. 733-771.
considerable losses for other financial institutions, including the central bank itself.5 In this
environment, a bank's private choice of liquidity buffers will not reflect what is socially
optimal.6
In the presence of such externalities, there is indeed a need for explicit regulation. This
leaves the choice open between regulating liquidity through prices (i.e. through interest rates)
and through quantities (i.e. liquidity buffers), hence the intimate interaction between
monetary policy and prudential regulation of liquidity.7
Similarly, an expectation of public sector intervention and support for banks in crisis can
create moral hazard and distort the incentives faced by financial institutions.8 As a
consequence, the liquidity buffers chosen by banks could be insufficient. Such
considerations call again for regulators to set and enforce prudential rules, and for central
banks to act in a way that jointly is socially optimal.
The new liquidity regulation: Basel III liquidity standards
Let me now discuss in some detail the Basel III liquidity standards agreed upon in December
2010. The international community, through the Basel Committee on Banking Supervision
(BCBS), drew up a proposal for liquidity risk regulation. The proposal includes two ratios, the
Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).
Under the LCR, banks are required to hold a minimum level of unencumbered high-quality
liquid assets (HQLA), the numerator of LCR, to withstand total net cash outflows over an
acute stress scenario lasting 30 days, the denominator of LCR. The LCR is specifically
designed to improve the short-term resilience of banks against liquidity shocks.
By contrast, the NSFR measures the amount of longer-term stable sources of funding
employed by an institution, the numerator of NSFR, relative to the liquidity profiles of the
assets funded and the potential for contingent calls on funding liquidity arising from
off-balance sheet commitments and obligations, the denominator of NSFR. Thus, the NSFR
requires banks to fund illiquid assets with a minimum amount of stable liabilities over a
horizon of one year.
Although the objectives of the LCR and NFSR are mainly microprudential in nature, some of
their characteristics also have macroprudential foundations, and therefore should have
systemic benefits. Still, they may have unintended consequences. In particular, I would like
to reflect on how they may interact with central bank operations.
5
See, for example, V. Acharya and S. Viswanathan, "Leverage, moral hazard, and liquidity", Journal of Finance
66, 2011; F. Allen and D. Gale. "Financial contagion", Journal of Political Economy 108, 2000; M.
Brunnermeier and L. H. Pedersen, "Market liquidity and funding liquidity", Review of Financial Studies 22,
2009; and R. Cifuentes, G. Ferrucci and H. S. Shin (2005), "Liquidity risk and contagion", Journal of the
European Economic Association 3, 2005.
6
See, for example, E. Perotti and J. Suarez, "A Pigovian approach to liquidity regulation", International Journal
of Central Banking 7, 2011.
7
Stein (2013) discusses liquidity regulation through price vs. quantities as a problem of social choice à la
Ronald Coase, drawing on the classical analysis by Weitzman (1974). Along these lines, if HQLA-eligible
assets are scarce, then the HQLA premium is likely to be both high and volatile and a price-based mechanism
can be more relevant than regulating quantities through the LCR. See J. Stein (2013), "Liquidity Regulation
and Central Banking", speech at the "Finding the Right Balance" 2013 Credit Markets Symposium sponsored
by the Federal Reserve Bank of Richmond, Charlotte, North Carolina, April 19, and M. Weitzman (1974),
"Prices vs. Quantities", Review of Economic Studies, vol. 41 (October), pp. 477-91.
8
Recent papers considering effects of government bail-outs on banks' maturity mismatch and financial stability
include E. Farhi and J. Tirole, "Collective moral hazard, maturity mismatch, and systemic bailouts", American
Economic Review 102, 2012, and T. Keister, "Bailouts and Financial Fragility", Federal Reserve Bank of
New York Staff Report No. 473, 2010.
Liquidity regulation and monetary policy implementation
Incentives on the asset side of banks' balance sheet
How will liquidity regulations and monetary policy implementation interact in normal times? In
my view, the interaction is expected to be complex and liquidity regulation may require
adjustments to central banks' operational frameworks.
Although the central bank collateral framework received more limited attention in the recent
academic literature than collateral used in private transactions,9 it is one of the most complex
and economically significant elements of monetary policy implementation. The interaction
between the collateral framework and liquidity regulation is of great importance, especially for
the Eurosystem.10
Let me illustrate this. A possible strategy for euro area banks to meet their LCR requirements
is to increase their reliance on central bank funding using non-HQLA collateral. This is due to
two features of the LCR calibration, which are of particular relevance for the ECB.
First, the LCR and the Eurosystem's monetary policy framework differ as regards the
definition of qualifying assets. The stock of HQLA accepted in the LCR is narrower than the
stock of assets which are eligible as collateral for the Eurosystem's monetary policy credit
operations. For example, asset backed securities (ABS) and uncovered bank bonds are
accepted as Eurosystem collateral, but do not qualify generally as HQLA in the LCR. In
addition, the LCR and the Eurosystem's collateral framework differ as regards haircuts that
are applied to specific categories of assets.11 Thus, there is no alignment between the
definition and the risk assessment of liquid assets and the central bank's collateral
framework. This is justified by the different purposes of liquidity regulation and of the central
bank's collateral framework: the collateral framework protects the balance sheet of the
central bank and, without prejudice to this objective, can support monetary policy
transmission to the economy, which calls for a broader range of eligible assets, especially in
such a diverse region as the euro area. This is also justified by the global nature of the LCR
while central banks frameworks are all different.
Second, unlike interbank funding, central bank refinancing over a 30-day horizon would not
count as an outflow in the denominator of LCR, as it always benefits from a 100% rollover
rate. As a result of these two features taken together, this could increase demand for central
bank refinancing. Banks could exploit regulatory arbitrage opportunities by posting
non-HQLA as collateral, which would lead to an increase in the LCR.12 While this also
9
An exception is Hilberg and Hollmayr (2011). They extend a New-Keynesian model introducing an interbank
market and allowing the central banks to alleviate the liquidity shortage on the interbank market varying
haircuts on eligible assets; see B. Hilberg and J. Hollmayr (2011), "Asset prices, collateral and unconventional
monetary policy in a DSGE model", European Central Bank working paper series, No 1373. For a discussion
on collateral used in private transactions see G. Gorton and A. Metrick (op. cit.) and J. Geanakoplos (2010),
"The Leverage Cycle" in D. Acemoglu, K. Rogoff and M. Woodford, eds., NBER Macroeconomic Annual 2009,
vol. 24, pp. 1-65, University of Chicago Press.
10
Bindseil (2013) discusses how the collateral framework can interact with liquidity regulation; see U. Bindseil
(2013) "Central bank collateral, asset fire sales, regulation, and liquidity", mimeo, European Central Bank. For
a description of the Eurosystem collateral framework, see the ECB website, http://www.ecb.europa.eu/
paym/coll/html/index.en.html.
11
Specifically, Level 1 assets are entirely taken into account in the LCR (no haircut) and thus benefit from a
more beneficial treatment in the LCR than in the Eurosystem's collateral framework, while level 2 assets
generally enjoy lower haircuts in the Eurosystem's collateral framework than in the LCR. These differences
certainly reflect the different objectives of the LCR and the Eurosystem's collateral framework.
12
Central bank refinancing always benefit from a 100% rollover rate no matter the quality of the assets used in
the transaction. A 100% rollover rate ensures equal treatment between central banks implementing monetary
policy through repo operations and central banks implementing monetary policy through outright purchases of
depends on the opportunity cost of obtaining liquidity from the Eurosystem, there may be a
number of LCR-constrained banks with large amounts of non-HQLA collateral that is eligible
for monetary policy operations.
Imagine a post-crisis monetary policy framework where the liquidity provision by the central
bank would again be rationed and implemented through competitive auctions (instead of
today's fixed rate, full allotment). If some banks have no access to market repos using their
assets as collateral (owing to concerns in the market place about country, counterparty or
collateral risk), it will be likely that these counterparties will bid in the liquidity-providing
monetary policy tender operations using this collateral in order to obtain cash to cover both
their funding needs and their LCR. All in all, one may therefore expect a general increase in
bid amounts and bid rates in tender operations, as well as adverse selection in the
participation to these operations.
Would this imply a changed risk profile of the Eurosystem's balance sheet? In principle no,
as the central bank is protected by its risk management framework, including a haircut
schedule calibrated to the credit and liquidity risk of pledged securities. But higher average
haircuts could imply a higher level of asset encumbrance on the balance sheets of banks,
with potential feedback loops onto the perception of credit risk at counterparty or even at
country level.
Let me give a second example of how the interaction between liquidity regulation and
monetary policy implementation might be expected to be complex, especially for the
Eurosystem. On one side, the regulation aims at reducing banks' undue reliance on central
bank liquidity, which is an intended consequence of the regulation. On the other side, the
regulation might lead to a situation in which some euro area banks, presumably the most
fragile, would rely more on the Eurosystem than otherwise. The central bank then risks
becoming a "lender of first resort".
Still, on this note, let me recall that the Eurosystem implements monetary policy in normal
times in an environment of a large and structural liquidity deficit by using temporary
liquidityproviding operations in the form of reverse repos. This implies that some reliance on central
bank funding is not undesirable, but rather wanted. The question is: how much is too much,
to the point where it would allow banks to sustain flawed business models?
Work is being carried out further on the interaction between the LCR and central bank
facilities so as to ensure that the LCR responds appropriately to the provision and withdrawal
of liquidity support by central banks. In this context, it has been proposed that central banks
provide a "Committed Liquidity Facility" (CLF) to banks faced with a scarcity of HQLA. Under
a CLF, the capacity to borrow from the central bank counts towards HQLA, with banks
paying an upfront fee for a determined amount of CLF commitment.
The CLF can potentially be useful not only in jurisdictions with a structural scarcity of HQLA,
like for example Australia. The argument put forward is that banks in crisis times, wary of
stigma effects, would not let their LCR ratio fall below 100 percent. A CLF, however, would
allow banks to meet the LCR ratio at all times, although with time-varying reliance on
privatemarket HQLA and on the CLF. One possibility would be for the central bank to encourage the
drawdown of private-market HQLA by reducing the pricing of the CLF during crisis time.
I would agree with Jeremy Stein13 that a CLF with an upfront fee is very different from
counting central-bank eligible collateral as HQLA at no cost, which could weaken the
incentive to borrow in markets and create excessive reliance on central bank funding. The
pricing of the CLF should therefore strike the right balance to protect monetary policy without
undermining the effectiveness of the LCR as a prudential instrument.
On the one hand, in order to reduce pressure on demand for central bank funding, it is
necessary that banks find it more attractive to pay the CLF commitment fee rather than to
obtain central bank liquidity and leave it on their accounts at the central bank. A CLF that
would only be used in stressed times would not serve our purpose. On the other hand, there
is a danger perceived by some that a CLF could materially change the effectiveness of the
LCR, as the definition of HQLA would de facto be substantially widened, which would offset
the objective that banks should self-insure against liquidity risk. To avoid such an outcome,
the following remedies exist: first, the pricing of the CLF in normal times should reflect the
opportunity cost of a bank for holding HQLA rather than non-HQLA. As a result, reliance on
the CLF should not be more attractive than holding private-market HQLA. Second, it has to
be borne in mind that access to the CLF needs to be collateralised; hence collateral
availability puts a "natural" limit to accessing HQLA in the form of a CLF.
Incentives on the liability side of banks' balance sheet
Having discussed how a bank can operate on the asset side of its balance sheet to improve
LCR compliance, I now turn to the liability side of its balance sheet.
A bank that faces the possibility of a LCR shortfall has the incentive to (i) decrease its
reliance on short-term unsecured funding, (ii) decrease the 30 days net cash outflow, and
(iii) to replace it by longer-term funding or, if this is too difficult or too expensive, by secured
funding. Since outflow rates are zero for secured funding obtained from the central bank, but
higher for secured funding obtained from other sources, the bank is more likely to borrow
from the central bank by pledging non-HQLA assets, either in tender operations or in the
marginal lending facility.14 As a result, this lessens the need of banks to seek funds in the
short-term interbank market to ensure that the LCR requirement is met.15
A reduction in the reliance on short-term unsecured funding is an intended consequence of
the LCR. However, the implementation of the LCR might then lead to an overall decline in
unsecured money market activity, which could be problematic for the euro area.
Money markets play a central role for monetary policy transmission in the euro area. This is
because the euro area financial system is largely bank-based, and interbank money market
interest rates represent the marginal cost of funding bank loans. When money markets
function normally, the ECB can influence the longer-maturity rates, which are relevant for
determining bank lending rates, by steering very short-term money market rates close to its
official rates. By the same token, a potential further decrease in depth of the unsecured
money market, in particular at the short-term, would further impair the role of the money
market in allocating and distributing liquidity in the euro area.
In addition, deep and liquid money markets play an important role in information aggregation
and price discovery. Indeed, money market rates, such as Euribor and Libor, provide
benchmark rates for the pricing of fixed-income securities and loan contracts throughout the
economy. Moreover, unsecured money markets play a key role keeping in check banks'
risk-taking profile.16 The LCR may induce an additional term premium in the unsecured
money market (as demand might not be fully matched by supply) and segmentation in the
market between maturities over and below 30 days. At the same time, by reducing liquidity
risk, the LCR may lead to lower liquidity risk premia. The overall effect of these two
countervailing forces is unclear though. While there could be an overall impact on the
difference between short and longer-term rates, to assess the overall impact on the monetary
policy transmission, one would need to see whether the transmission from short to
longerterm rates would be also affected. However, it remains to be seen whether unsecured
lending beyond 30 days will revive after the crisis.
As mentioned, this new set of liquidity requirements is expected to have important
consequences for limiting solvency risk and encouraging good risk management. In fact, the
regulation is expected to bring an overall positive effect on the functioning of the money
market by internalising the negative externalities for financial stability and monetary policy,
i.e. reducing information asymmetries concerning banks' liquidity risk exposure and their
liquidity risk bearing capacity, creating the conditions for a better functioning of the money
market.17
This has to be combined with actions ensuring a proper functioning of the money market
(such as oversight of reference rates along the lines recently proposed by the European
Commission). It should also be seen as a complement to regulatory reforms that will improve
market discipline in other segments of the banks' liability structure, such as capital buffers
and the new bail-in rules for senior bond-holders and uninsured depositors. And since bail-in
rules have confirmed that insured depositors are protected by deposit guarantee schemes,
meaning by the taxpayer, the banking supervisor is the public authority to whom insured
depositors delegate the monitoring of bank behaviour - hence the need for strong banking
supervision, free of national political influence.18
Liquidity regulation and lender of last resort
Finally, let me turn to the interplay between the ex ante regulation of liquidity ratios and the
ex post provision of liquidity assistance in time of stress by the central banks.
Walter Bagehot famously advocated that a lender of last resort in a crisis should lend freely
at a penalty rate to solvent but illiquid banks that have adequate collateral.19 Such
intervention is seen as the primary method for mitigating the adverse systemic effects of a
liquidity crisis, providing stability to the banking system and avoiding unfavourable
consequences for the real sector.
Since the onset of the crisis, to prevent market-wide liquidity problems from turning into
solvency problems for individual banks, the Eurosystem introduced, as of October 2008, a
discipline in the unsecured money markets as a provision of ex ante incentives to mitigate risk of borrowers'
investments; see M. Hoerova and C. Monnet, "Money market discipline and central bank lending", presented
at the workshop on the "Post-crisis design of the operational framework", mimeo, European Central Bank,
2011.
17
The effects of asymmetric information and counterparty credit risk on the interbank market functioning are
analysed in F. Heider, M. Hoerova and C. Holthausen, "Liquidity hoarding and interbank market spreads: The
role of counterparty risk", ECB Working Paper No. 1126, 2009.
18
See B. Coeuré (2013), "The implications of bail-in for bank activity and stability", opening speech at the
conference on "Financing the recovery after the crisis - the roles of bank profitability, stability and regulation",
Bocconi University, Milan, 30 September.
19
The LOLR should lend freely against good collateral, valued at pre-crisis levels, and at a penalty rate. These
conditions are due to Bagehot (1873) and are also presented, for instance, in Humphrey (1975) and Freixas,
Parigi and Rochet (2004); see W. Bagehot, "Lombard street", H.S. King, London, 1873; Humphrey, T. "The
classical concept of the lender of last resort", Economic Review, 61, 2-9, 1975; and Freixas, X., Parigi B., and
J.-C. Rochet "The lender of last resort: A 21st century approach", Journal of the European Economic
Association, 2: 1085-1115, 2004.
fixed-rate, full allotment regime in its refinancing operations, offering unlimited liquidity to
banks at a predictable cost against an expanded set of eligible collateral. The widening of
collateral might be seen as a way to mitigate the adverse and destabilizing effects of
shortterm funding "runs" relating to a deterioration of asset liquidity, but it can also be seen as a
way to prevent large recourse to central bank liquidity by banks, who would otherwise be
subject to funding outflows at a later stage of the crisis. Such a widening has to be
accompanied by proper risk management measures, such as haircuts, to mitigate the
increase of the risk profile of the central bank. The challenge for the central bank is to
"buildin" the possibility to expand the set of eligible collateral while mitigating the incentives for
banks to abuse it.20
Similarly, the LOLR's function of providing emergency liquidity assistance has been criticised
for provoking moral hazard by banks. Indeed, support that is considered as appropriate
during the crisis might have perverse effects on the incentives of banks at a later stage.
Banks may ex ante decide to take an excessive exposure to risk, knowing that the central
bank will intervene if that risk materialises. Moreover, there is a fine line between liquidity and
solvency needs, which in a crisis is often blurred. Central banks should therefore be
particularly wary not to substitute for capital support that should be provided by shareholders,
investors, or in last resort by governments. When such moral hazard problems are severe,
the central bank might consider mitigating but not eliminating the externalities of a liquidity
crisis - that is, not helping barely solvent banks and thus providing incentives for banks to
conduct business in safe and sound manner.21 The challenge for the central bank is to find
the appropriate balance between preserving financial stability and imposing discipline for the
future.
While the new set of liquidity standards requires banks to hold sufficient liquid assets in good
times to meet their outflows in a given stress scenario, it does not exclude the possibility that
central bank liquidity support will be needed if events turn out even worse than that scenario.
One solution could be to further increase the liquidity requirements. However, additional
liquidity requirements aimed at mitigating systemic shocks could constitute a "waste" of
liquidity, given that they would be used only under exceptional circumstances. On this note,
the emergence of a "home bias" following the global financial crisis poses the risk of an
additional "waste" of liquidity. The ring-fencing of capital and liquidity by local supervisors
have constrained banks' risk-taking outside domestic jurisdictions and banks' ability to
transfer and allocate liquidity across jurisdictions in which they operate. Lack of cooperation
in the implementation of the new regulatory standards has a potential to lead to overprovision
of self-insurance against solvency and liquidity risks, when capital could be invested for a
more productive use.
Alternatively, a solution would consist in requiring banks to form pools of liquidity and to sign
multilateral credit lines commitments, specifying the conditions under which an illiquid bank
would be allowed to draw on its credit line. However, the risk of coordination failures is
substantial and a purely private solution, by shifting inside liquidity around the system, does
not address the aggregate liquidity need that arises in the case of systemic shocks.22 In such
a situation, the public sector should intervene and provide outside liquidity ex-post.
Conclusion
Let me conclude.
In my remarks today, I have focused on new liquidity regulations and have argued that the
interaction with monetary policy implementation is expected to be significant and complex. I
would therefore conclude that liquidity regulation and central bank operations cannot be
looked at in isolation.
The new set of liquidity requirements will provide for a better monitoring of risks on banks'
balance sheets and will limit the social cost of liquidity crises. It has to be combined with
actions ensuring a proper functioning of the money market, such as reform and oversight of
reference rates. It should be seen as a complement to regulatory reforms that improve
market discipline in other segments of the banks' liability structure, such as capital buffers
and the new bail-in rules for senior bond-holders and uninsured depositors.
A more far-reaching question, which I did not address in this speech, is whether the
increased risk-sensitivity of bank liabilities under the new regulatory regime will constrain the
role of banks as providers of liquidity services to the economy, or as creators of
"q