Liquidity regulation and the implementation of monetary policy

In addition to revamping existing rules for bank capital, Basel III introduces a new global frame-work for liquidity regulation. One part of this framework is the liquidity coverage ratio (LCR), which requires banks to hold sucient high-quality liquid assets to survive a 30-day period of market stress. As monetary policy typically involves targeting the interest rate on loans of one of these assets { central bank reserves { it is important to understand how this regulation may impact the ecacy of central banks ' current operational frameworks. We introduce term funding and an LCR requirement into an otherwise standard model of monetary policy implementation. We show that when banks face the possibility of an LCR shortfall, it becomes more challenging for a central bank to control the overnight interest rate and the short end of the yield curve becomes steeper. Our results suggest that central banks may want to adjust their operational frameworks as the new regulation is implemented