In this paper, we explore the banking market competition with the onset of a liquidity shock. Using a simple model of the spatial monopolistic competition, we show that banks hold lower level of liquid assets than the socially desirable level. On the other hand, when the liquidity requirement is imposed, banks are forced to increase liquid assets which have inferior returns than illiquid assets. This will lead banks to prefer funding to low-cost deposits from high-cost deposits. Our paper suggests that the liquidity regulation of Basel III Accord can be justified as a necessary tool in stabilizing the financial system but only at the expense of decline in both the depositor wealth and the social welfare.