Tighter UK bank liquidity rules have not affected lending 24 October 2014 5:03PM John Kavanagh Tighter bank liquidity rules introduced in the United Kingdom in 2010 have not resulted in a reduction in lending or an increase in the cost of finance, a study by the Bank for International Settlements has found.The individual liquidity guidance rules, introduced by the UK's Financial Services Authority, are similar to the Basel III liquidity coverage ratio rules, which take effect in Australia next year. The LCR rules are intended to make sure banks can deal with a short-term liquidity crisis. Approved deposit-taking institutions will have to maintain an adequate level of high-quality liquid assets that can be converted into cash to meet liquidity needs for 30 days, with no access to financial markets.There has been debate in Australia about the possible negative impact of liquidity regulation on bank lending since the LCR rules were finalised in 2013. Industry groups have argued that liquidity regulation will increase the cost of bank funding and damage the real economy as banks pass on higher costs, reduce credit supply or both.The UK study outlined a number of ways a bank could meet tighter liquidity requirements. It could increase the ratio of high-quality liquid assets to stressed liability outflows by shrinking its balance sheet through a reduction in lending.A bank could attract more stable household deposit funding and use the proceeds to acquire high-quality liquid assets, increasing the size of its balance sheet in the process.Or a bank could substitute liquidity held as infra-financial loans for government bonds without affecting lending to the non-financial sector.In the UK in 2010 some banks were granted waivers, which provided the authors of the study with a "control group" for their research.They found that the UK banks covered by tighter liquidity rules adjusted both their asset and liability structures to meet the regulations."However, we do not find evidence that the tightening of liquidity regulation had an impact on the overall size of bank balance sheets or a detrimental impact on lending," the study said.Banks subject to the rules increased their share of high-quality liquid assets by 12 percentage points, relative to those with waivers.The increase in high-quality liquid assets was matched by an almost equal reduction in the share of short-term intra-financial loans. Therefore, banks replaced private liquidity with official sector liquidity"We did not find evidence that banks reduced their non-financial lending," the study reported.On the liability side, banks increased funding from sources considered more stable under the FSA rules and reduced dependence on short-term wholesale funding and non-resident deposits."We did not find evidence that banks increased the interest rate paid to attract those deposits, and there is little evidence that banks increased interest rates on loans to the non-financial sector," the study said.It concluded: "Because the [UK rules] reduced intra-financial claims without having a measurable impact on the price or quantity of lending to the real economy, our results suggest that liquidity regulation could be a useful macroprudential tool for reducing the transmission of shocks through a highly interconnected financial sector."