The leverage ratio and liquidity in the gilt and gilt repo markets

Market participants argue that a significant unintended consequence of post-crisis regulatory leverage ratio requirements is a reduction in the liquidity of fixed income markets. We assess this claim in the context of the gilt (U.K. government bond) and gilt repo markets over the period 2010 to 2017. We find that gilt repo liquidity worsened during the period when U.K. leverage ratio policy was introduced, and that gilt liquidity worsened conditional on factors such as funding costs and inventory risk. We also find evidence that gilt repo liquidity has become less resilient. However, evidence from heterogeneity in dealer behavior is inconclusive regarding a causal link between leverage ratio requirements and the reduction in market liquidity.