Liquidity Regulation, Bank Complexity and Policy: GFC vs COVID-19 Crisis

We introduce a general equilibrium model to analyze the interactions between liquidity regulations and banks’ investment in complex assets. Complexity improves bank liquidity in good times but heightens vulnerability to runs during crises. Banks underinvest in complex assets when liquidity regulations are loose and overinvest when liquidity regulations are tight. Liquidity regulations qualitatively affect the structure of complementary ex-ante policies, such as asset-specific taxes, but they can also undermine the benefit of ex-post interventions that support interbank loan prices, such as quantitative easing. The implications of the model are examined empirically in the context of the Liquidity Coverage Ratio.