The Basel III net stable funding ratio adjustment speed and systemic risk

The theory on the timing of liquidity trades highlights two contrasting rational expectations equilibria for the liquidity adjustment speed effect, namely an immediate-trading equilibrium (trade at the onset of the liquidity shock) and a delayed-trading equilibrium (trade at the last resort). Using a partial adjustment model and an annual data sample of US bank holding companies from 1991 to 2012, we investigate the effect of Net Stable Funding Ratio (NSFR) adjustment speeds on systemic risk. We find that banks with the immediate-trading equilibrium tend to adjust the NSFR quickly in response to the Basel III liquidity requirement, thereby, reducing systemic risk. With the same level of the NSFR, our findings suggest that only the adjustment speed exerts a negative impact on systemic risk. Our evidence shows that small banks strengthen the effects of the negative impact of the NSFR adjustment speed on systemic risk. Our study sheds light on a real-time indicator of the NSFR for Basel III revisions before its implementation in 2018