The Impact of Basel III Liquidity Requirements on the size of the banking sector in Europe

Abstract

Having acknowledged that the size of the banking sector in Europe has grown significantly in the years before the crisis and that the banking sector has shown significant liquidity deficiencies in 2007, this paper aims at investing whether the liquidity requirements introduced by Basel III in 2011 have contributed to the reduction of the size of total amount of bank financing in European countries. The author conducts a quantitate analysis on a sample of 100 European banks (ranked by total assets) to understand how European countries have complied with this regulation. In particular, the focus is placed on whether European countries have reduced the total amount of bank financing provided to the non – financial sector and on whether the total assets of banks per country have decreased as a result of the introduction of liquidity requirements. The main findings of this paper are that liquidity requirements imposed by Basel III contributed to the reduction of the size of the banking sector and of the total amount of bank financing in Europe. On the other hand, it also demonstrates that capital requirements imposed by Basel III did not have a statistically significant effect on these two variables, suggesting to the reader that capital requirements did not affect the size of banks. Liquidity regulation have, as expected, reduced the amount of lending for banks, which, after the crisis have reduced their reliance on complicated financial instruments and have turned their business toward more safe forms of operations as retail banking. The structure of the paper is set up as follows. The first part is dedicated to a literature review analysis and an extensive description of liquidity regulation before and after the crisis. The author describes in the third chapter the details of Basel III requirements. In the second part of the paper the author describes the methodology and data used, as well as the econometric specifications applied in the analysis. Finally, in the last section the paper provides the empirical results obtained and an analysis of their implications and limitations.