Interactions of bank capital and liquidity standards within the Basel 3 framework: A literature review

We discuss the various channels and mechanisms highlighted in the academic literature on how liquidity and capital interact and how bank behavior is affected by such interaction. Whether liquidity and capital standards need to be jointly implemented (complementarity) or not (substitutability) has not reached a consensus in the literature and depends on the specific transmission channel considered by each study. Whereas one strand of the literature focuses on banks’ risk-taking behavior under the joint capital-liquidity constraint, other papers emphasize the implication for lending and economic performance. Drawing from this lack of consensus, we highlight directions for future research in this area which is at its burgeoning stage and make some recommendations.