A prudential stable funding requirement and monetary policy in a small open economy

The Basel III net stable funding requirement, introduced in January 2018, requires banks to use a minimum share of long-term wholesale funding and deposits to fund their assets. A similar regulation has been in place in New Zealand since 2010. We introduce the stable funding requirement (SFR) into an open-economy DSGE model featuring a banking sector with richly-specified liabilities, and estimate the model for New Zealand. We then evaluate the impact of the new prudential instrument on monetary policy trade-offs. A higher steady-state SFR level amplifies the effects of shocks to the spread on long-term bond financing in the banking sector, adding to macroeconomic volatility conditional on these shocks. However, the SFR plays a passive role in the transmission of all other shocks to the real economy. Hence in the overall picture, the monetary policy trade-off between inflation stabilisation and output stabilisation, is only slightly worsened by the SFR. We note that the trade-off can be improved when monetary policy responds systematically to credit growth.