Of note, the long-standing U.S. tier 1 leverage ratio also requires the same amount of regulatory capital for all assets, but the SLR has been more binding given its higher calibration and more expansive coverage of exposures. The SLR is currently the binding capital requirement for some dealers, and it has significantly increased the amount of capital that needs to be held against low-risk assets. This has resulted in significant adjustments in the composition of dealer balance sheets. For example, the imposition of the SLR has been cited as an important factor in the shrinkage of dealer repo financing activity. In contrast, the risk-based capital standards and new liquidity standards are unlikely to be important for Treasuries and repo backed by Treasuries because Treasuries are treated as posing less risk to the banks that hold them and count as high-quality liquid assets. For the corporate bond market, the most relevant factors are probably the increase in the Basel risk-weighted capital ratio, the Comprehensive Capital Analysis and Review (CCAR) stress tests – which subject the dealer trading book to additional global market shocks that include a sudden increase in general risk premiums and credit risk combined with significant market illiquidity – and the Volcker Rule, which prohibits proprietary trading for a number of asset classes including corporate bonds, but not U.S. Treasuries. However, for both markets, other non-regulatory factors are also important.
Even if one were to read the evidence as supporting the notion that liquidity has become somewhat more costly, this does not imply that we should simply unwind recent regulatory requirements. First, as I discussed, there are non-regulatory factors that could be more important factors. Second, even if a connection could be made to regulatory causes, the costs of any reduction in liquidity or increase in liquidity risk might be low relative to the benefits of the regulations. As I noted at the outset of my remarks, recent regulatory changes have been designed to produce a safer and sounder financial system. Higher capital and liquidity requirements have made major financial institutions less prone to failure. This can be seen in the sharp fall in credit default swap spreads for major dealers in recent years. Moreover, other steps have made the financial system more robust to the failure of a systemically important firm. For example, the shift to central clearing of over-the-counter derivatives through central counterparties (CCPs) has reduced bilateral risk exposures, and significant progress is being  2  The Federal Reserve’s large scale asset purchases presumably have also played a role by removing a large volume of Treasury securities from the marketplace. BIS central bankers’ speeches  5  made on how to resolve the failure of a systemically important financial firm in a way that does not threaten the entire financial system. 3 As I see it, the prior regime did not sufficiently foster financial stability, a necessary condition for sustained economic growth.