We examine the impact of usury law removal on bank liquidity creation by exploiting the 1999 Gramm-Leach-Bliley Act’s repeal of Arkansas' strict interest rate cap as a natural experiment. Using a difference-in-differences framework, we find that deregulation significantly increased liquidity creation among large banks, while small banks reduced liquidity provision due to heightened competition. Our results also show that financial strength influences the ability to capitalize on deregulation, as banks with higher profitability and capital abundance experienced stronger liquidity creation growth. Additionally, we show that removing interest rate ceilings enhanced the transmission of monetary policy and reshaped loan portfolios, with large banks expanding commercial lending and mortgages while small banks expand consumer loans. Finally, we document intensified competition post-deregulation. Our study provide novel evidence on how interest rate (de)regulations shape liquidity creation, monetary policy transmission, and market competition.

The stability of the financial system heavily relies on effective liquidity risk management, a lesson underscored by the Global Financial Crisis and recent banking turmoil. The current regulatory framework, particularly the Liquidity Coverage Ratio (LCR), aims to ensure individual banks’ liquidity resilience. However, this approach does not fully address systemic liquidity risk, which requires a broader perspective encompassing multiple financial institutions. This research introduces a novel measure, Systemic Liquidity Coverage at Risk (S-LCRisk), which extends the LCR concept to a systemic level. By evaluating the joint liquidity risk across financial institutions, S-LCRisk provides a comprehensive tool for regulators to monitor and mitigate systemic liquidity crises.

We investigate the usage of liquidity management tools (LMTs) in open-ended mutual funds, focusing on the effectiveness of LMT usage, rather than just availability, in reducing the first-mover advantage motive for run-like redemptions from funds with liquidity mismatches. Although purposefully designed to mitigate fund fragility, and often regarded by regulators as having macroprudential benefits, usefulness and effectiveness of LMTs in practice is still subject to some debate. This paper studies this problem utilizing a large- scale survey conducted by the Central Bank of Ireland, a rare and valuable data for the usage of LMTs within a substantial cohort of EU-regulated funds. We show that quantity-based LMTs, although widely available, are rarely used by funds. In contrast, price-based LMTs, despite being less widely available, are often used. We consider the use of LMTs as an endogenous decision reflecting the flightiness of investors and the fund investment strategy. We address this endogeneity issue with fund family’s LMT availability as an instrument. We find that the use of price-based LMTs significantly reduces the risk of large net outflows and improves performance when funds are under stress. The identified effects are stronger than those for the availability of price-based LMTs. Among the individual price-based LMTs, full swing pricing has the strongest effects.

The traditional approach to the stress testing of financial institutions focuses on capital adequacy and solvency. Liquidity stress tests have been applied in parallel to and independently from solvency stress tests, based on scenarios which may not be consistent with those used in solvency stress tests. We propose a structural framework for the joint stress testing of solvency and liquidity: our approach exploits the mechanisms underlying the solvency-liquidity nexus to derive relations between solvency shocks and liquidity shocks. These relations are then used to model liquidity and solvency risk in a coherent framework, involving external shocks to solvency and endogenous liquidity shocks arising from these solvency shocks. We define the concept of “Liquidity at Risk”, which quantifies the liquidity resources required for a financial institution facing a stress scenario. Finally, we show that the interaction of liquidity and solvency may lead to the amplification of equity losses due to funding costs which arise from liquidity needs.