Regulatory Efficiency and Strategic Adjustment under Multiple Banking Constraints

About the Project

Banks operate under multiple binding regulatory constraints, most notably capital and liquidity requirements designed to ensure resilience to economic shocks. While these requirements strengthen financial stability, they are costly: holding additional equity or liquid assets reduces balance sheet flexibility and may constrain profitability. Banks must therefore comply with overlapping regulatory ratios while managing trade-offs between stability and performance.

Despite substantial separate research on capital and liquidity regulation, considerably less attention has been paid to their interaction. In particular, little is known about whether banks can jointly optimize compliance across multiple constraints in a way that reduces economic cost without increasing financial instability. A recent review by the Bank of England highlights that the literature on the interaction between capital and liquidity requirements remains at an early stage and that significant gaps persist (Vo, 2021).

This PhD project will investigate regulatory efficiency, which is the extent to which banks comply with multiple regulatory requirements at minimum cost while maintaining resilience. The core premise is that when several regulatory ratios bind simultaneously, banks may face uneven levels of tension across them. Some banks may be able to restructure their balance sheets to exploit slack in one constraint and relieve pressure in another, for example through adjustments to asset composition, liability structure, or capital allocation. The extent to which banks are able, or willing, to undertake such restructuring remains unknown.

The research is designed to be flexible in geographic scope. Depending on data availability and candidate interest, the project may focus on a single country, undertake a cross-country European analysis, or compare banking systems across regions (e.g., Europe and the United States). This flexibility allows the candidate to tailor the empirical design while contributing to a broadly relevant policy debate.

Key research questions include:

• How can banks adjust their balance sheets to improve one regulatory ratio while preserving stability and controlling costs?
• How does compliance with liquidity requirements influence capital structure decisions and performance outcomes?
• To what extent do banks leave potential regulatory efficiency gains unexploited, and what are the associated economic implications?
• What institutional, structural, or behavioural barriers limit efficient adjustment?
• Have past regulatory adjustments unintentionally affected financial stability?

By integrating insights from banking, regulation, and corporate finance, the project aims to contribute to academic research and inform policymakers on how regulatory frameworks can promote both stability and efficiency in the banking system.

Supervisors

Dr Kenneth Baldwin

Associate Professor

Dr Shang Jiang

References

Vo, Q.A., 2021. Interactions of capital and liquidity requirements: a review of the literature. Available at SSRN 3829231.