Does Excessive Liquidity Creation Trigger Bank Failures?

35 Pages Posted: 6 Feb 2013 Last revised: 31 Jan 2014

See all articles by Zuzana Fungáčová

Zuzana Fungáčová

Bank of Finland - Institute for Economies in Transition (BOFIT)

Rima Turk-Ariss

International Monetary Fund; Economic Research Forum

Laurent Weill

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

Date Written: January 21, 2013

Abstract

This paper introduces the “Excessive Liquidity Creation Hypothesis,” whereby a rise in a bank’s core liquidity creation activity increases its probability of failure. Russia experienced many bank failures over the past decade, making it an ideal natural field experiment for testing this hypothesis. Using Berger and Bouwman’s (2009) liquidity creation measures, we find that excessive liquidity creation significantly increased the probability of bank failure during our observation period (2000−2007). This finding survives multiple robustness checks. Our results further suggest that regulatory authorities can mitigate systemic distress and reduce the costs to society from bank failures through early identification and enhanced monitoring of excessive liquidity creators.​

Keywords: liquidity creation, bank failures

JEL Classification: G21, G28

Suggested Citation

Fungacova, Zuzana and Turk-Ariss, Rima and Weill, Laurent, Does Excessive Liquidity Creation Trigger Bank Failures? (January 21, 2013). BOFIT Discussion Paper No. 2/2013. Available at SSRN: https://ssrn.com/abstract=2211486 or http://dx.doi.org/10.2139/ssrn.2211486

Zuzana Fungacova (Contact Author)

Bank of Finland - Institute for Economies in Transition (BOFIT) ( email )

Snellmaninaukio
PO Box 160
Helsinki 00101
Finland

HOME PAGE: http://www.bof.fi/bofit_en/index.htm

Rima Turk-Ariss

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Economic Research Forum ( email )

21 Al-Sad Al-Aaly St.
(P.O. Box: 12311)
Dokki, Cairo
Egypt

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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