Enough liquidity with enough capital—and vice versa?

We study the interplay of capital and liquidity regulation, focusing on future funding risks. Our model features a banking sector with access to long-term illiquid investment opportunities, financed through short-term debt and equity issuance. The reliance on refinancing midway through the investment cycle is risky, as future investors may withhold funding if return prospects deteriorate. We derive two main findings. First, when liquidity shortfalls are rooted in concerns about future solvency, optimal capital regulation directly addresses the underlying fragility and renders liquidity regulation redundant. Second, in the absence of sufficient capital buffers, liquidity regulation can act as a partial substitute by stabilizing the bank’s asset side and improving resilience to shocks.