The Spillover Effect of Liquidity Transparency on Liquidity Holdings

Abstract

I study how the disclosure of the liquidity coverage ratio mandated for a group of systemically important U.S. banks affects peer banks' liquidity holdings. I predict that the disclosure mitigates uncertainty about aggregate liquidity risk by providing insight into the likelihood of market-wide liquidity shocks and specific sources of liquidity stress. This uncertainty resolution, in turn, reduces nondisclosing banks' precautionary demand for liquidity. Using bank business interactions to measure the treatment intensity of the disclosure, I find that more treated nondisclosing banks cut their liquidity significantly more in response to the disclosure. In addition, the disclosure rule was followed by lower overall liquidity and a build-up of systemic risk, indicating an economically considerable disclosure spillover effect in the aggregate. My paper reveals a new economic force, the spillover effect of mandated liquidity disclosure, that shapes banks' liquidity holdings.