RBNZ review liquidity risk

 Reserve Bank Bulletin looks at market liquidity conditions

Financial market participants have become increasingly worried in recent years about a decline in the level and resilience of global financial market liquidity, raising concerns about the efficiency of markets and increased risks associated with a liquidity shock.

The Bulletin article reviews international research on the topic, and generally finds evidence for a decline in the level and resilience of liquidity, although it has been mixed across markets.  High levels of liquidity as well as strong resilience are important for the efficient functioning of financial markets and optimal capital allocation.

The primary drivers for the decline in liquidity have been increased regulations on market makers and a changing market structure. Extraordinarily easy monetary policy has added to liquidity, and is likely masking the full structural decline in liquidity. This means lower financial market liquidity may become even more apparent when major central banks eventually tighten monetary conditions again

The article also assesses liquidity conditions in the New Zealand government bond, funding and short-term money markets using common analytical measures of liquidity, as well as drawing on discussions with numerous market participants. The article finds that liquidity has declined to varying degrees across the different markets, and while risks of a liquidity shock have risen, the decline has been manageable thus far.

More information: Reserve Bank Bulletin

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