07-01-2026
Financial regulations are typically designed to influence the behavior of banks, investors or other regulated entities. Yet new research by Daniels School Assistant Professor of Accounting Jacob Ott shows how regulatory changes can ripple far beyond their intended targets, reshaping entirely different markets and influencing organizational decision-making.
Published in The Accounting Review, Ott's study, "The Regulatory Spillover Effects of Classifying Municipal Bonds as High-Quality Liquid Assets," examines how changes to bank liquidity regulations affected municipal bond pricing and altered financing decisions by state and local governments. The findings offer an important lesson for executives, managers, investors and policymakers: regulations can create opportunities, risks and unintended consequences throughout the broader economy.
Following the 2008 financial crisis, banking regulators introduced stricter liquidity requirements under Basel III. One key provision, the Liquidity Coverage Ratio (LCR), requires banks to hold sufficient high-quality liquid assets (HQLA) to withstand periods of financial stress.
Initially, municipal bonds were excluded from assets that banks could count toward these requirements. In 2015, however, the Federal Reserve proposed allowing certain highly rated general obligation municipal bonds to qualify as HQLA while continuing to exclude revenue bonds.
Although the change appeared highly technical, Ott's research demonstrates that it had significant effects on the municipal bond market and ultimately influenced how municipalities financed public projects.
Traditional finance theory suggests that shifts in investor demand unrelated to an asset's underlying fundamentals should have limited long-term effects on pricing. Ott's findings challenge that assumption.
The study found that municipal bonds eligible for HQLA treatment experienced lower yield spreads relative to ineligible revenue bonds following the regulatory announcement. Yield reductions averaged roughly four to five basis points, with larger effects among highly rated bonds most likely to qualify for HQLA status.
The explanation is straightforward. Because qualifying bonds helped banks satisfy liquidity requirements, banks increased their demand for those securities. Greater demand pushed prices higher and borrowing costs lower for issuers.
Importantly, these pricing effects persisted over time rather than quickly reversing. The findings suggest that regulatory classifications can create lasting value in financial markets, even when the underlying economics of the securities remain unchanged.
For business leaders, the broader takeaway is that asset prices and capital costs are not always driven solely by operational performance or market fundamentals. Regulatory frameworks can meaningfully influence investor preferences and capital allocation decisions.
Perhaps the study's most significant finding is what happened after borrowing costs changed.
Municipalities that had flexibility to issue either general obligation bonds or revenue bonds adjusted their financing strategies. As eligible bonds became less expensive to issue, municipalities shifted a greater share of their debt issuance toward those securities.
In other words, organizations responded quickly to the incentives created by regulation.
This behavior illustrates an important reality of modern markets. Even organizations that are not directly regulated may change their strategies when regulations alter economic incentives. As Ott notes, regulatory accounting changes can influence "the economic behavior of entities that are not even subject to the regulatory accounting ratio itself."
The research also highlights several practical lessons for executives and managers navigating increasingly complex regulatory environments:
Many organizations focus only on regulations that directly govern their operations. This study demonstrates why that approach may be too narrow.
Leaders should monitor policy developments affecting key stakeholders throughout their ecosystem, including banks, investors, suppliers, customers, and industry partners. Changes in those areas can create indirect but significant consequences.
Regulations frequently alter investor preferences and capital allocation decisions.
Finance teams should evaluate whether regulatory changes create opportunities to access lower-cost financing, improve capital structures, or reposition assets to benefit from shifting demand.
Municipal issuers that had flexibility in how they financed projects were able to capitalize on changing market conditions.
Similarly, businesses benefit from maintaining multiple financing options. Flexibility allows organizations to respond when market conditions or regulations create temporary advantages.
Strategic planning often focuses on direct impacts. The stronger approach is to ask what happens next.
How might customers respond? How might lenders adjust behavior? How could competitors reposition themselves? The most important opportunities and risks often emerge through these second-order effects.
Ott's research demonstrates that accounting and regulatory classifications are far more than administrative details. They can influence investor behavior, reshape markets and alter organizational decision-making in ways regulators may not fully anticipate.
The lesson extends well beyond municipal bonds. In an interconnected economy, regulatory changes rarely affect only their intended audience. Organizations that understand how new rules alter incentives across the marketplace are better positioned to anticipate change, identify opportunities and gain a competitive advantage.
