On regulation and excess reserves: The case of Basel III

Common explanations for the observed rise in excess bank reserves include payment of interest on reserves and liquidity regulations, but capital regulations may also matter. We show that a profit‐maximizing bank substitutes from higher risk‐weighted loans to lower risk‐weighted reserves and Treasuries if the risk‐based capital ratio, but not the leverage ratio, increases. Estimated treatment effects for “advanced approaches” bank holding companies, the focus of Basel III capital regulations, initially increased for reserves after the regulatory changes but later decreased when treatment effects for Treasuries increased as Treasury yields rose; treatment effects for loans became increasingly negative.