The Price of Safety: How Basel III’s Liquidity Rules Are Constraining Investment Across Europe, EMDEs and Africa

2

By Dr. Vera Songwe, Nonresident Senior Fellow, Africa Growth Initiative, Brookings

 

 

 

 

The Liquidity Coverage Ratio (LCR) is one of the most consequential reforms to emerge from Basel III (the third of the three Basel Accords issued by the Basel Committee on Banking Supervision [BCBS]). Introduced after the Global Financial Crisis (GFC), it was designed to ensure that banks hold sufficient high-quality liquid assets (HQLA) to survive a severe 30-day stress scenario without immediately relying on emergency official support.1 In that narrow sense, the reform has been a success: Banks today are structurally more liquid than they were before 2008, and systemwide resilience to short-term funding shocks is materially stronger.2,3

The issue is no longer whether the LCR makes banks safer; it is whether the cost of that safety is being borne in ways that adversely affect investment, growth and financial structure.

In the current environment, in which the need for climate-transition investment is at an all-time high and global growth is low, the urgency to ensure that policy does not impede investment is growing. The issue is no longer whether the LCR makes banks safer; it is whether the cost of that safety is being borne in ways that adversely affect investment, growth and financial structure.

In Europe, EMDEs (emerging markets and developing economies) and Africa, in particular, where banks remain central to business finance and long-term credit intermediation, very high liquidity buffers are impacting the economics of lending to infrastructure, small and medium-sized enterprises (SMEs) and energy-transition projects.4 In emerging markets and developing economies, the same framework can be harder to implement because domestic pools of liquid assets are smaller, local markets are shallower, and banks play an even more dominant role in financing economic development.5,6 In Africa, where the need for investment is greatest, the consequences are more acute.

For many countries facing multiple exogenous shocks, high costs of capital and dwindling concessional capital, the current question is how liquidity regulation under Basel III can be made more context-sensitive. How can the reform account for the real trade-offs between financial-sector resilience and growth-enhancing investment? Financing the transition, particularly in many EMDEs and in Africa, with their huge demographic pressures, is existential. Financials are more remote. It is feasible, but only in a system that understands the tensions and can calibrate them based on the system’s impacts on national, regional and global financial markets. This is absent today.5,7

Why the LCR matters after 2008

The Basel Committee developed the LCR in response to a core lesson of the 2008 crisis: Many banks that appeared well-capitalised could still fail quickly when wholesale funding evaporated, and supposedly liquid assets became difficult to sell without deep discounts. The LCR’s structure was meant to prevent this by requiring banks to hold a stock of unencumbered HQLA at least equal to their total projected net cash outflows over 30 days under a severe-stress scenario.1

That logic remains compelling. Pre-crisis banking models underpriced liquidity risk, relied excessively on unstable short-term funding and assumed market liquidity would remain available even during systemic stress.1 The 2013 revisions to the rule broadened the definition of eligible liquid assets and eased some parameters, but the underlying principle remained intact: Banks should maintain a credible liquidity buffer that can be used when markets freeze.

The rule’s strength, however, is also the source of its economic tension. Because it privileges cash, central-bank reserves and sovereign paper, it naturally raises the regulatory value of liquid assets relative to long-dated, illiquid and harder-to-trade exposures.7,8 That means the LCR does not merely protect banks; it changes their incentives, their balance-sheet compositions and, potentially, the volume and tenor of credit they are willing to extend.7 For Africa, it created a definition that did not provide for a diversified base of HQLA.

The numbers show stronger liquidity

On aggregate metrics, the Basel III liquidity reforms have worked. The Basel Committee’s monitoring exercise based on end-June 2024 data found that the weighted average LCR for Group 1 internationally active banks stood at 136 percent, comfortably above the 100-percent requirement. For Group 2 banks in the balanced sample, the weighted average LCR reached 194 percent, with no aggregate shortfall since June 2017.2

In Europe, the numbers are even more striking. The European Banking Authority (EBA) reported that European Union (EU) banks’ average LCR rose by three percentage points between June 2023 and June 2024 to reach 167 percent, supported by increased holdings of liquid assets.3 Earlier EBA monitoring had already shown that the average LCR stood at around 149 percent in both June and December 2018, with an aggregate gross shortfall of €15.7 billion concentrated in just four banks that had monetised buffers in stress conditions.9 The regulation is binding, and banks are adhering—excessively.

Europe: safer banks, but at what cost to investment?

Europe’s experience is important because its financial system, like Africa’s, remains more bank-based than that of the United States. European firms, especially SMEs, still depend heavily on bank intermediation, which means that prudential-liquidity rules affect not only treasury portfolios but also credit supply, loan maturity and investment financing.4 Understanding the impacts of the reform on Europe helps to understand the impacts on EMDEs and Africa in particular.

In both Europe and Africa, inherent tension exists. Banks that seek to optimise their LCRs have an incentive to hold more sovereign bonds, reserves and other HQLA, all else equal.1,7 But balance-sheet space is finite. The larger the commitment to liquid assets, the greater the opportunity cost for lending activities, such as project finance, infrastructure credit or other forms of long-duration lending with cash flows that are less liquid and regulatory treatment less favourable under the Basel III framework.4,7

Africa, even more than Europe, must acquire the resources to finance decarbonisation, the energy transition, and transport and logistics infrastructure; develop a mineral value-addition industrial policy; close the digital gap and address increasing security issues. If prudential rules steer banks too strongly toward liquid sovereign assets and away from private long-term lending, the result may be a safer banking system that is less effective at supporting the very growth needed to sustain financial stability.4

The sovereign-bank nexus complicates the picture further in Africa. Because sovereign bonds are the most, if not the only, regulatory-efficient forms of HQLA, banks have a natural incentive to hold them in large sizes. As in Africa and the euro area, this can reinforce home biases and keep banking-sector liquidity management tightly linked to national fiscal conditions. The framework, therefore, reduces some kinds of risk while potentially deepening another: the feedback loop between sovereign stress and banks’ balance sheets.10

EMDEs: Basel rules in shallower markets

EMDEs face a harder version of the same problem because the Basel III template was designed largely around large, internationally active banks operating in deep markets with broad sovereign yield curves, functioning repo (repurchase agreement) markets and abundant domestic HQLA.1,5 Many EMDEs lack those conditions.6

EMDEs often confront narrow local-currency bond markets, more volatile capital flows, greater foreign-exchange risks and supervisory systems that are still deepening. In that setting, strict implementation of the LCR can produce unintended consequences: concentrated sovereign holdings, substitution into foreign-currency liquid assets and a reduced appetite for long-term domestic lending.5

The external financing environment now makes these vulnerabilities more acute. The International Monetary Fund (IMF) reported in April 2026 that cumulative portfolio flows to emerging markets had increased eightfold since the Global Financial Crisis to around $4 trillion, while portfolio-debt liabilities in emerging markets averaged roughly 15 percent of gross domestic product (GDP), up from 9 percent in 2006.11,12 The Fund also found that nonbanks now provide 80 percent of this capital, roughly double the share seen two decades earlier.11 EMDEs are therefore more connected to market finance but also more exposed to changes in nonbank investor behaviour.12

This shift matters for the LCR because a bank can comply with a liquidity ratio while the market liquidity of its supposed liquid assets deteriorates under stress. If foreign portfolio investors sell EM sovereign debt aggressively, local yields can spike, currencies can weaken, and the marketability of bank-held HQLA can fall at precisely the moment those buffers are supposed to be usable.12,13 The IMF’s recent warning about “flighty”hedge-fund capital in emerging markets highlights this systemwide fragility.11,13

This is why the debate in EMDEs cannot be limited to whether banks satisfy the LCR on paper. The deeper question is whether the assets counted as HQLA remain reliably liquid under the specific stress conditions most relevant to these economies—sudden stops, foreign-exchange pressures and sharp nonresident outflows.5,6

Africa: liquidity resilience amid development scarcity

What Africa faces highlights an even deeper tension; it illustrates both the usefulness and the limits of the Basel III liquidity reform. Across the continent, implementation has been predictably uneven, reflecting differences in market depth, supervisory capacity, currency structure and the availability of domestic liquid assets.14,15

An Alliance for Financial Inclusion (AFI) survey found that 68 percent of African jurisdictions and respondents had implemented Basel III in some form, but only 14 percent had fully adopted the framework, while 54 percent had implemented it partially. Among those partial adopters, capital requirements and the LCR were among the most commonly prioritised elements.14 This indicates that African regulators are not rejecting Basel III.14,15

Evidence suggests that this approach has yielded real stability benefits. A 2022 study of 45 listed banks across six African countries found an average LCR of 181.7 percent and concluded that, among the Basel III variables examined, the LCR was the only one with a statistically significant positive effect on bank stability.16

However, Basel III rules risk penalising African systems if the net result is that they raise funding costs and encourage banks to favour government securities over private-sector credit in economies where long-term finance is already scarce. This is not an abstract fear. In many African markets, sovereign paper is one of the few readily available forms of HQLA, which means the LCR can naturally tilt balance sheets toward public debt and away from SME lending, infrastructure finance and trade-supporting credit.5

Country evidence illustrates the point. South Africa’s banking-system LCR trended upward from 2015 to 2022 and remained above the Basel threshold throughout the period, with a notable dip only around the 2020 shock, before recovering.17 This high concentration of HQLA in the form of government securities is happening at the same time that South Africa is facing huge challenges accessing the market to fund growth or accelerate the green-transition agenda. If banks are highly liquid while development-finance gaps remain large, is the regulatory mix adequately supporting productive intermediation?18

Finding the optimal intersection between stability and growth is the challenge. For Africa, the answer is unlikely to be a wholesale dilution of Basel III. A more credible path would include broader recognition of domestic liquid instruments wherever appropriate, stronger collateral and repo infrastructures, targeted tools to address foreign-currency liquidity risks and greater use of development-finance and/or central-bank facilities to complement balance-sheet liquidity requirements.5 In short, the continent may need Basel III discipline—but not Basel III by rote.15

What recalibration should look like

The best supportive policy response for growth, job creation and investment, as discussed earlier, is not to abandon deregulation but to recalibrate it.

The best supportive policy response for growth, job creation and investment, as discussed earlier, is not to abandon deregulation but to recalibrate it. For Europe, it means confronting the sovereign-bank nexus more directly, ensuring that the prudential stack does not unduly penalise productive long-term lending and widening macroprudential attention to nonbank liquidity mismatches.19 For EMDEs, it means applying Basel III proportionally, adjusting HQLA definitions wherever justified, managing foreign-currency liquidity risk explicitly and recognising that shallow markets require different implementation paths.5,6 For Africa, it means sequencing reform around market development, supervisory capacity and development priorities rather than adopting advanced-economy templates wholesale.14,15

Financial stability and growth must align. Investment and low-cost finance are the most important resources needed in Europe, EMDEs and Africa. A more mature regulatory framework must bridge liquidity policy, focusing not only on whether banks can survive 30 days of stress but also on whether the financial system can continue to fund investment without amplifying systemic fragility. The LCR succeeded in forcing banks to value liquidity more highly. The next stage of Basel III should ensure that, in doing so, regulators do not end up undervaluing investment.1,7 With Europe and EMDEs facing the same challenges, this is hopefully one piece of Basel III reform that garners immediate support. It is more than friction; it is material for growth.

 

 

ABOUT THE AUTHOR

Vera Songwe is a nonresident senior fellow in the Global Development and Africa Growth Initiative at the Brookings Institution. She is the founder and chair of the board of the Liquidity and Sustainability Facility, as well as Professor in Practice at the London School of Economics’s Centre for Economic Transition Expertise (CETEx). Previously, she served as United Nations Under-Secretary-General and Executive Secretary of the United Nations Economic Commission for Africa.

 

 

References

1 Bank for International Settlements (BIS): “Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools,” January 7, 2013.

2 Bank for International Settlements (BIS): “Highlights of the Basel III monitoring exercise as of 30 June 2024.”

3 European Banking Authority (EBA): “EU banks’ liquidity coverage ratio increased in June 2024, underpinned by growth in banks’ holdings of liquid assets,” December 13, 2024.

4 Banque de France: “Financial Stability Review,” No. 19.

5 “Making Basel III Work for Emerging Markets and Developing Economies,” Thorsten Beck, Erik Jones and Peter Knaack, 2019. See the Center for Global Development (CGD) Task Force Report.

6 Centre for Economic Policy Research (CEPR)/VoxEU: “Making Basel III work for emerging markets,” Liliana Rojas-Suarez and Thorsten Beck, May 4, 2019.

7 Moody’s Analytics: “Optimizing Assets under Basel III LCR Requirements,” Lorenzo Boldrini and Yashan Wang, January 2020.

8 Morgan Stanley: “Basel III: Impact on the Money Markets,” 2018.

9 European Banking Authority (EBA): “EBA publishes the regular Basel III capital monitoring report and an update on liquidity measures.”

10 World Bank/International Monetary Fund (IMF) analysis on South Africa’s sovereign-financial nexus.

11 IMF Blog: “As Emerging Markets Attract More Nonbank Capital, They Also Face New Challenges,” Salih Fendoglu, Mahvash S. Qureshi and Felix Suntheim, April 7, 2026.

12 International Monetary Fund (IMF): “Capital Flows to Emerging Markets: The Role of Global Nonbank Investors,” Global Financial Stability Report, April 2026, Chapter 2.

13 Financial Times: “IMF warns of emerging markets’ exposure to ‘flighty’ hedge funds,” Delphine Strauss, April 7, 2026.

14 Alliance for Financial Inclusion (AFI): “Survey Report on the Implementation of the Basel Framework,” September 21, 2018.

15 Munich Personal RePEc Archive (MPRA)/Emerald Insight: “Basel III in Africa: Making It Work,” Peterson K. Ozili, 2019.

16 Scientific Research Publishing (SCIRP): “Banking Regulation Effects on African Banks’ Stability,” Ayodeji Michael Obadireorcid, December 2022, Journal of Financial Risk Management, Volume 11, Number 4.

17 Statista: “Liquidity-coverage ratio (LCR) of the banking industry in South Africa from 2015 to 2022.”

18 Banco de Moçambique: “Financial Stability Bulletin – 2024,” December 19, 2024.

19 Financial Times: “Letter: Europe cannot escape the contagion in private credit,” Rosemary McCollin, April 1, 2026.

20 Financial Times: “Europe needs more private credit, not less,” Richard Milne, March 25, 2026.

21 The Journal of Corporate Accounting & Finance: “Impact of Basel III liquidity and capital regulations on bank lending and financial stability: Evidence from emerging countries,” Anil K. Sharma and Rosy Chauhan, March 30, 2023.