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Basel III, The Money Multiplier And Monetary Policy

ByBNP Paribas
AuthorPhilippe d'Arvisenet
Published 01/20/2014, 05:43 AM
Updated 03/09/2019, 08:30 AM

The introduction of international liquidity standards in response to the 2007 financial crisis represents one of the main innovations under Basel III. In the short term, the Liquidity Coverage Ratio (LCR) determines the minimum quantity of liquid assets that banks must hold to cover outflows of cash triggered by a 30-day liquidity crisis. In the longer term, the new Net Stable Funding Ratio (NSFR) means that bank loans with a maturity of more than one year will have to be matched with funding of an at least equivalent maturity or sufficiently stable.

The short-term liquidity ratio, the main focus of this article, aims to keep a grip on credit institutions’ liquidity risk. It curbs their exposure (reducing maturity transformation and making them less reliant on shortterm market funding) and increases their ability to deal with liquidity risk by giving them a buffer of high-quality liquid assets. Aside from the ultimate purpose of making the banking system more resilient to a liquidity shock, this new standard interacts with monetary policy and the financing of the economy. It thus represents a new priority for central bankers.

First and foremost, the LCR aims to make the banking system less reliant on central banks at times of stress. Paradoxically, though, it will make it more reliant on them in normal conditions (first part). What’s more, economic theory suggests that the LCR may cut the money multiplier and squeeze the private-sector funding by banks to some extent (second part). Lastly, the operation of the money market and monetary policy transmission may also be disrupted (third part).

BY Laurent QUIGNON

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