The Impact of the Basel III Liquidity Regulations on the Bank Lending Channel: A Luxembourg case study

In this paper we study the impact of the Basel III liquidity regulations, namely the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR), on the bank lending channel in Luxembourg. For this aim we built, based on individual bank data, time series of the LCR and NSFR for a sample of banks covering between 82% and 100% of total assets of the banking sector. Additionally, we simulated the optimal balance sheet adjustments needed to adhere to the regulations. We extend the existing literature on the identification of the bank lending channel by adding as banks characteristics the estimated shortfalls in both the LCR and NSFR. We find a significant role for the bank lending channel in Luxembourg which mainly works through small banks with a large shortfall in the NSFR. We also show that big banks are able to increase their lending following a contractionary monetary policy shock, in line with the fact that big banks in Luxembourg are liquidity providers. Our extrapolation and simulation results suggest that the bank lending channel will no longer be effective in Luxembourg once banks adhere to the Basel III liquidity regulations. We find that adhering to the NSFR may reduce the bank lending channel more strongly than complying with the LCR.