The Impact of Bank Liquidity on Bank Risk Taking: Do High Capital Buffers and Big Banks Help or Hinder?
45 Pages Posted: 19 Aug 2014 Last revised: 9 Jun 2019
Date Written: July 31, 2015
This study examines the impact of bank liquidity on bank risk taking. Using quarterly data for U.S. bank holding companies from 1986 to 2014 we find evidence to support that more liquid banks take more risk. This key result is robust for alternative bank risk and liquidity proxies, including some new liquidity measures advocated under the Basel III regulatory framework. An increase in banks’ short-term liquidity increases banks’ non-performing assets, risk-weighted assets and stock return volatility. The relation is stronger for banks with high capital buffers and in the high liquidity post-GFC era. However, our results show that bank size usually limits banks from taking more risk when they are flushed with liquidity but this was not the case during the more recent post-GFC high liquidity sub-period. The findings of this study have implications for bank regulators advocating greater liquidity and capital requirements for banks under Basel III.
Keywords: Liquidity, bank risk, asset risk, liquidity risk, capital buffer, bank size
JEL Classification: G21, G01, G18
Suggested Citation: Suggested Citation