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From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity?

Author

Listed:
  • Gideon Saar
  • Jian Sun
  • Ron Yang
  • Haoxiang Zhu
  • Itay Goldstein

Abstract

Postcrisis bank regulations raised market-making costs for bank-affiliated dealers. We show that this can, somewhat surprisingly, improve overall investor welfare and reduce average transaction costs despite the increased cost of immediacy. Bank dealers in OTC markets optimize between two parallel trading mechanisms: market making and matchmaking. Bank regulations that increase market-making costs change the market structure by intensifying competitive pressure from nonbank dealers and incentivizing bank dealers to shift their business activities toward matchmaking. Thus, postcrisis bank regulations have the (unintended) benefit of replacing costly bank balance sheets with a more efficient form of financial intermediation.

Suggested Citation

  • Gideon Saar & Jian Sun & Ron Yang & Haoxiang Zhu & Itay Goldstein, 2023. "From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity?," The Review of Financial Studies, Society for Financial Studies, vol. 36(2), pages 678-732.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:2:p:678-732.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhac068
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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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