Abstract
We study the cross-sectional effects of Basel regulations on dealer intermediation in the U.S. corporate bond market. Using intra-quarter variation in the intensity of Basel regulatory requirements, we document pronounced inventory contractions when regulatory pressure rises near quarter-ends. While balance sheet space becomes the dominant constraint with the introduction of the leverage ratio, risk-based capital requirements constrain corporate bond intermediation already before. This has important implications for bond intermediation in the cross-section of dealers: In contrast to their behavior in short-term money markets (Correa, Du, and Liao, 2022), U.S. bank-affiliated dealers do not absorb regulatory selling pressure in corporate bonds. Instead, bank-affiliated dealers—irrespective of jurisdiction—direct their selling pressure primarily to nonbank financial intermediaries. In doing so, they fall back on their customer networks to offload investment grade bonds and their nonbank dealer networks to dispose of high-yield bonds. In balance sheet intensive trades we document regulatory shadow costs of up to 20%. Our findings have implications for the design of future regulation of both bank and non-bank financial intermediaries