Last summer I contributed a post about the Liquidity Coverage Ratio (LCR), a new regulation that is part of the latest international Basel Accords (Basel III) and that is being imposed on U.S. banks and other financial institutions. As I explained in that post, the LCR requires banks to hold “high quality liquid assets” (HQLA) sufficient to cover potential net cash outflows over 30 days. Both George Selgin and I have pointed out that the LCR probably contributes to the continuing desire of banks to maintain such a high level of reserves.
Two economists who have severely criticized the LCR are Gary Gorton, noted for his work on bank panics, and his co-author, Tyler Muir. Earlier this year they published online a short version of a much longer unpublished paper that scrutinizes the potential impact of the LCR. Whereas my post, appropriately entitled “Reserve Requirements Basel Style,” compared the LCR to the traditional but now largely abandoned reserve requirements imposed on banks, Gorton and Muir compare it to the bond-collateral (or bond-deposit) requirement of the national banking era, prevailing from the Civil War until creation of the Federal Reserve. They conclude that the LCR will cause the same sorts of problems that, ironically, the Fed was supposed to solve.