Outside the LCR Box : The Impact of Liquidity Regulation on Banks in China

This study investigates the far-reaching effects of a liquidity regulation policy on the banking sector in China. Since 2014, banks subject to the liquidity coverage ratio (LCR) have neither significantly increased their holdings of qualified high-quality liquid assets, nor significantly reduced the proportion of loan assets. The response of banks to the LCR has mainly been on the liability side. Regulated banks have significantly decreased their short-term wholesale funds via traditional interbank business, while increasing another novel type of funding, namely interbank negotiable certificates of deposit (NCDs). The combined effect of these two interbank debt instruments has improved the LCR ratio for regulated banks relative to non-regulated banks. This implies that the LCR has not yet achieved its objective in China, and the design of liquidity regulation should consider incentives to innovate around it