de Conference on “ Liquidity and Liquidity Risks ”

This paper discusses liquidity regulation when short-term funding is the marginal funding source of credit growth but generates negative systemic risk externalities. It studies the relative merits of price versus quantity tools, showing that a second best solution may generally involve the use of both types of tools. When banks differ in their credit opportunities, a Pigovian tax on short-term funding ensures efficient liquidity regulation. Quantity-based net stable funding ratios also contain systemic risk but are distorsionary because they are not tailored to each bank’s opportunities; mandatory liquidity buffers are either not effective or similar to an implicit tax on short-term funding (but with larger deadweight costs). When banks widely differ in their gambling incentives (e.g. due to large heterogeneity in charter value), excess credit may be better controlled with quantity constrains. The case for a tax on short-term funding reemerges if capital requirements keep risk shifting incentives under control.