The Effects of Liquidity Regulation on Bank Demand in Monetary Policy Operations Marcelo Rezende, Mary-Frances Styczynski, and Cindy Vojtech 1 Federal Reserve Board 1The views expressed herein are our own and do not necessarily reflect those of the Board of Governors or the staff of the Federal Reserve System. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 1 / 26
Motivation • Academics and policymakers have argued that liquidity regulation may affect bank behavior in monetary policy operations. • As far as we know, no empirical evidence of this effect. • We examine the effects of a liquidity requirement on bank behavior in one monetary policy tool. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 2 / 26
We Attempt to Fill This Gap • We estimate the effects of the Liquidity Coverage Ratio (LCR) on the participation of banks in Term Deposit Facility (TDF) operations. high-quality liquid assets i bank i ’s LCR = projected net cash outflow over 30 days i • Excess reserves qualify as high-quality liquid assets (HQLA) . • Term deposits are deducted from excess reserves. • Therefore, the LCR may lower participation in TDF operations. • Challenge: LCR coverage and TDF participation are endogenous. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 3 / 26
Empirical Strategy: Difference-in-Differences Methodology • We use variation in LCR coverage. • We also use variation in a key characteristic of TDF operations, the Early Withdrawl Feature (EWF) . • The EWF allows banks to withdraw term deposits before maturity, making those deposits qualify as HQLA. • Thus, banks covered by the LCR may be more interested in participating in TDF operations with an EWF. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 4 / 26
Motivation of Testing Strategy, Participation Rate Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 5 / 26
Motivation of Testing Strategy, Participation Rate Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 6 / 26
Motivation of Testing Strategy, Participation Rate Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 7 / 26
Liquidity Coverage Ratio (LCR) • Two versions of the LCR: the standard and the modified. • The standard LCR applies to All U.S. bank holding companies (BHCs) with $250 billion or more in 1 total consolidated assets, or Banking organizations with $10 billion or more in on-balance-sheet 2 foreign exposures - And depository institutions with assets of $10 billion or more under (1) or (2). • Institutions subject to the standard version must have an LCR of at least 80, 90, and 100 percent by January 2015, 2016, and 2017. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 8 / 26
Liquidity Coverage Ratio (LCR) • The modified LCR applies to BHCs that do not meet the standard LCR thresholds but have $50 billion or more in total assets. • Institutions subject to the modified version must have an LCR of at least 90 and 100 percent by January 2016 and 2017. • We assume that the standard and the modified LCR affect banks equally. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 9 / 26
HQLA Holdings by LCR Bank Groups High-quality liquid assets (HQLA) to total assets ratio High-quality liquid assets (HQLA) to total assets ratio Percentage points Percentage points 20 20 Start of EWF 18 18 Standard LCR banks Standard LCR banks Modified LCR banks Modified LCR banks 16 16 Non-LCR banks Non-LCR banks 14 14 12 12 10 10 8 8 Q4 Q4 6 6 4 4 2 2 0 0 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 10 / 26
Term Deposit Facility (TDF) • The TDF is a tool to control market interest rates. • As part of the tests of the TDF, the Federal Reserve has changed many characteristics of the term deposits offered. • In particular, while past operations did not allow banks to withdraw funds prior to maturity, all operations since October 2014 include an EWF, subject to a pecuniary penalty. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 11 / 26
TDF Operation Characteristics Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 12 / 26
Data • Panel of bank-operation pairs. • Bank data (3,687 banks): - Dependent variables: Dummy for submitting a tender and Dollar amount of tender - Other bank characteristics, including assets, HQLA, and excess reserves • TDF operations data (16 operations): - EWF dummy Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 13 / 26
Empirical Strategy: TDF Participation • We estimate the following equation: = α LCRBank ij + β LCRBank ij × t + γ LCRBank ij × t × EWF j Y ij + ν i + ϕ j + ε ij , (1) • where - Y ij is a dummy for bank i offering a tender in operation j . - LCRBank i and EWF j are dummies for the LCR and the EWF. - t is a time trend equal to one when the EWF starts. - ν i is a bank random effect, ϕ j an operation fixed effect, and ε ij an idiosyncratic error. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 14 / 26
Results: TDF Participation Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 15 / 26
Empirical Strategy: Tender Amounts (Tobit Estimation) • We estimate the following equation: B ij = C j , if C j < Y ij = (2) Y ij , if R j ≤ Y ij ≤ C j = 0 , if Y ij < R j , • where - B ij is the tender amount submitted by bank i in operation j . - Y ij is still determined by equation (1) but is now the latent value of bank i ’s tender amount in operation j . Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 16 / 26
Results: Tender Amounts Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 17 / 26
Robustness: Foreign Banks • We now present additional results that rely on foreign banks which can be as large but are not subject to the U.S. LCR requirement. • More specificaly, we estimate the following equation: Y ij = α DOM i + β DOM i × t + γ DOM i × t × EWF j + ν i + ϕ j + ε ij , (3) • where all variables are defined as before except for DOM i . DOM i = 1 for domestic banks DOM i = 0 for U.S. branches and agencies of foreign banks Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 18 / 26
Results: Foreign Banks Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 19 / 26
Concluding Remarks • Liquidity regulation affects bank demand in the TDF. • Open question: Does liquidity regulation affect transmission of monetary policy through banks? - If liquidity regulation affects demand for term deposits, it could also affect demand for excess reserves. - Some evidence that amount of excess reserves affects transmission of monetary policy through banks. - More broadly, evidence that bank characteristics affects the impact of monetary policy on bank credit supply. Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 20 / 26
APPENDIX APPENDIX Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 21 / 26
Appendix: Bank Size Distribution Number of Depository Institutions 600 600 $50 Billion 500 500 400 400 300 300 200 200 100 100 0 0 0.5 0.79 1.3 2 3.2 5 7.9 13 20 32 50 79 130 200 320 500 790 1300 2000 3200 5000 Total assets ($ Billions) Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 22 / 26 Participation Rate
Appendix: Foreign Counterfactual Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 23 / 26
Appendix: Foreign Counterfactual Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 24 / 26
Appendix: Foreign Counterfactual Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 25 / 26
Robustness: Bank Characteristics Rezende, Styczynski, and Vojtech Liquidity Regulation & Bank Demand September 29, 2016 26 / 26
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