Advancing Understanding of the Impact of Financial Regulation on Dollar Funding
20 Years of SFI—A Look behind the Scenes of World-Class Finance Research
As part of SFI's 20th anniversary celebrations, we are showcasing a selection of finance research conducted by SFI faculty members. Today, SFI ranks among the top 10 finance institutes worldwide. Each edition of our showcase features one SFI professor, presenting their research area, key insights, and the practical impact of their work.
At their core, these blog posts reflect what lies at the heart of SFI: fostering world-class research, advancing knowledge, and bridging research and practice—all contributing to the long term prosperity of Switzerland's financial marketplace and the country as a whole. SFI, growing knowledge capital for the last 20 years and in the years to come.
This edition features SFI Professor Angelo Ranaldo from the University of Basel and his research on how regulations affect financial markets in terms of liquidity.
An important driver behind SFI Professor Ranaldo's work is to provide valuable information to support the proper functioning and stability of the financial system. He brings this focus to his work as a member of the Bank Council of the Swiss National Bank, advisor to several international institutions, researcher, and mentor to the next generation of Finance professors.
His academic research focuses on examining the key frictions and inefficiencies that impact the financial system. The financial system can be compared to the human body, where smooth coordination is essential for proper functioning. Like the nervous system, which relies on signals from the brain to trigger movement, asset prices react to news and adjust as new information is released. Yet information alone is not enough to generate movement—liquidity acts like the blood in the system, helping to dispatch resources and ensure that movements occur quickly and efficiently.
SFI Professor Ranaldo's research centers on liquidity—the blood flow of financial markets—and its different layers. In particular, he studies how regulations affect financial markets in terms of liquidity. After the implementation of the Basel III regulatory framework, SFI Professor Ranaldo and coauthors noticed evidence suggesting that leverage ratio reporting requirements were affecting global dollar funding.
"Before beginning a research project, I ask myself if the research matters for society, particularly for policymakers and financial institutions, but also for investors and market participants. Is there something we could learn to make the financial system more efficient, resilient, and ultimately fairer?"
The Unintended Consequences of Banking Regulation
Since the implementation of Basel III, the principle of covered interest parity (CIP)—which normally ensures that borrowing through foreign exchange (FX) markets costs the same as borrowing directly in money markets—has persistently broken down, indicating a premium for synthetic US dollar funding through FX swaps. SFI Professor Ranaldo and coauthors explored the origins of these distortions and found that Basel III banking regulation and its uneven implementation across countries plays a crucial role in segmenting global dollar funding markets. In particular, they show that balance sheet regulation penalizes non-US agents' access to wholesale dollar funding, which leads them to pay a premium for synthetic US dollar funding. While US dealer-banks can source dollar liquidity through their domestic deposits and central bank reserves, non-US banks usually rely on secured, wholesale funding, which consumes costly balance sheet space. On the other hand, FX swaps are an off-balance-sheet item. When regulatory constraints bind, for example at quarter-end, these agents turn to synthetic dollar borrowing as an imperfect substitute, but must pay a premium for such unencumbered funding—thus explaining the deviations from CIP. The overall effect is that post-crisis balance sheet regulation has unintentionally segmented the global dollar funding network, leading to large cross-border transfers of economic rents and raising the cost of hedging for the non-US real economy. In other words, when the financial system's blood flow is distorted, the effects spread beyond financial institutions and affect the broader economy.
The research by SFI Professor Ranaldo and coauthors helped inform regulatory discussions that led to a more harmonized implementation of Basel III reporting requirements across jurisdictions. These changes have helped ease—though not eliminate—segmentation in global dollar funding markets and associated CIP distortions.
More Information
- Segmented Dollar Funding, Journal of Financial Economics (with P. Kloks and E. Mattille)
SFI Prof. Angelo Ranaldo (UNIBAS)
Angelo Ranaldo is a Professor of Finance and Financial Economics at the University of Basel and holds an SFI Senior Chair. He has served as a consultant and scientific advisor to international institutions such as the Bank of England, the Bank for International Settlements, the European Central Bank, the European Money Market Institute, and the International Monetary Fund. He is also a member of the Bank Council of the Swiss National Bank. He studies the key frictions within the financial system that undermine its efficiency and stability.
His research focuses on three interrelated and mutually reinforcing frictions: market illiquidity, balance sheet constraints of financial intermediaries, and institutional factors such as monetary regulation and policies.
"It is important to me that my work provides value to society. One part of this is in preparing the next generation of academics. I supervise several SFI PhD students, and I try to impart to them this value of pursuing finance research that answers an important question for society and advances knowledge."