The prudential role of Basel III liquidity provisions towards financial stability

Abstract

This paper examines the prudential role and the effectiveness of banking regulation in EU. Using a unique sample of banks' balance and off-balance sheet data, we focus on the capital requirements (tier1) and the liquidity characteristics of the banking sector. The latter factor is accounted for by the Basel III net stable funding ratio (NSFR) that was launched on 2010 with effect on 2018 and refers to the long-term liquidity provision of banks. By adopting a dynamic panel-vector autoregression (VAR) analysis, we have found strong evidence in favor to the forecasting and prudential supervision role of NSFR, which provides the means for improving banks' performance and for promoting the stability in the banking sector. On the other hand, capital requirements (tier1) incorporate a responsive component to uncertainty in the financial system. Finally, our findings support the prudential role of Basel III liquidity provisions, which can play the role of leading indicators of financial stability of financial markets and specifically of the financial sector. © 2021 John Wiley & Sons, Ltd.