On 15 September 2017, Darrell Duffie (Graduate School of Business, Stanford University) delivered the Thirteenth Paolo Baffi Lecture, in which he addressed the implications of the capital structure of dealer banks for the liquidity of financial markets. Professor Duffie argued that post-crisis regulatory reforms have shrunk the balance sheet capacity of dealers, thereby reducing the supply of market-making services and liquidity.
In particular, the regulatory leverage ratio has compressed the profitability of market-making into low-risk fixed-income instruments. According to Duffie, an improvement in market liquidity could be achieved at no cost to financial stability by changing the system of capital requirements, with a different balance between risk-based and non-risk-based measures.
A different – possibly complementary – way to improve market liquidity would be to accelerate reforms with the aim of enhancing competition and price transparency. In the euro area, repo markets have experienced fewer pronounced adverse liquidity effects than in the United States thanks to several mitigating factors, including the lower regulatory leverage ratio for European banks, the widespread diffusion of active electronic platform trading markets and greater recourse to central clearing.
