03 October 2013

ECB/Coeuré: Liquidity regulation and monetary policy implementation – From theory to practice

Coeuré argues that the interaction with monetary policy implementation is expected to be significant and complex. He therefore concludes 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 he did not address in his 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 “quasimoney”.

If so, this could put undue pressure on central banks as producers of the only truly safe and liquid asset – bank reserves. This makes it even more important for governments to be fiscally responsible so that Treasuries can keep or regain their role as safe and liquid instruments.

Mr Coeuré said: “Going forward, central banks will continue to act as lenders of last resort, but the crisis has helped us better understand the conditions for it to be socially useful. One of these is an effective liquidity regulation that constrains the business models of banks in a way that ensures that liquidity risk is self-insured. If properly priced, instruments such as a Committed Liquidity Facility can complement liquidity regulation while protecting monetary policy.”

Another condition is that the resort to central bank liquidity should be expensive, bounded in time, and addresses only emergency situations. This matters particularly in the euro area, where overreliance on central bank funding, including emergency liquidity assistance, can delay the necessary restructuring and changes in banks’ business models.

And finally, there should remain a strict separation between capital and liquidity assistance that reflects the division of tasks between central banks on the one hand, shareholders and fiscal authorities on the other hand and avoids that monetary policy is held hostage of financial or fiscal dominance. Liquidity ought to be provided to the banking system as needed, but it should not be a substitute for a lack of capital.

Full speech

© BIS - Bank for International Settlements