Bank Capital and Liquidity Creation: Granger-Causality Evidence

32 Pages Posted: 15 Dec 2012

See all articles by Roman Horvath

Roman Horvath

Charles University in Prague; IOS Regensburg; Université de Nice Sophia Antipolis - Groupe de Recherche en Droit, Economie et Gestion (GREDEG); University of Saint Etienne - Analysis Group and Economic Theory Lyon St-Etienne (GATE-LSE)

Jakub Seidler

Czech National Bank (CNB); Charles University in Prague - Department of Economics

Laurent Weill

University of Strasbourg - LaRGE Research Center (Laboratoire de Recherche en Gestion et Economie)

Date Written: November 20, 2012

Abstract

We examine the relation between capital and liquidity creation. This issue is interesting because of the potential impact on liquidity creation from tighter capital requirements such as those in Basel III. We perform Granger-causality tests in a dynamic GMM panel estimator framework on an exhaustive data set of Czech banks, which mainly includes small banks from 2000 to 2010. We observe a strong expansion in liquidity creation until the financial crisis that was mainly driven by large banks. We show that capital negatively Granger-causes liquidity creation in this industry, where majority of banks are small. But we also observe that liquidity creation Granger-causes a reduction in capital. These findings support the view that Basel III can reduce liquidity creation, but also that greater liquidity creation can reduce banks’ solvency. Thus, we show that this reverse causality generates a trade-off between the benefits of financial stability induced by stronger capital requirements and the benefits of increased liquidity creation.

Keywords: Bank capital, Liquidity creation, Basel III

JEL Classification: G21, G28

Suggested Citation

Horvath, Roman and Seidler, Jakub and Weill, Laurent, Bank Capital and Liquidity Creation: Granger-Causality Evidence (November 20, 2012). ECB Working Paper No. 1497, Available at SSRN: https://ssrn.com/abstract=2178383 or http://dx.doi.org/10.2139/ssrn.2178383

Roman Horvath (Contact Author)

Charles University in Prague ( email )

Celetná 13
Praha 1, 116 36
Czech Republic

IOS Regensburg

Landshuter Str. 4
Regensburg, 93047
Germany

Université de Nice Sophia Antipolis - Groupe de Recherche en Droit, Economie et Gestion (GREDEG)

250, rue Albert Einstein
Valbonne, 06560
France

University of Saint Etienne - Analysis Group and Economic Theory Lyon St-Etienne (GATE-LSE)

Lyon
France

Jakub Seidler

Czech National Bank (CNB) ( email )

Na Prikope 28
CZ-11503 Praha 1
Czech Republic

Charles University in Prague - Department of Economics

Opletalova 26
Prague, 11000
Czech Republic

Laurent Weill

University of Strasbourg - LaRGE Research Center (Laboratoire de Recherche en Gestion et Economie) ( email )

61 Avenue de la Forêt Noire
F-67085 Strasbourg Cedex
France

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