Liquidity Creation and Bank Capital
Journal of Financial Services Research, Forthcoming
Posted: 25 Aug 2016 Last revised: 9 Oct 2018
Date Written: October 3, 2018
This paper aims to evaluate the relationship between capital and liquidity following the implementation of the Basel III rules. These regulatory measures target both increased capital ratios and a reduction of banks’ maturity transformation risk, which could result in excessive constraints on bank liquidity creation, thereby negatively affecting economic growth. Using a simultaneous equation model, we find a bi-causal negative relationship, which suggests that banks may reduce liquidity creation as capital increases; and when liquidity creation increases, banks reduce capital ratios. Our results therefore imply a trade-off between financial stability (higher capital, reduced risk) and economic growth (liquidity creation).
Keywords: bank capital, liquidity creation, illiquidity, net stable funding ratio, Basel III, eurozone banking system
JEL Classification: G21, G28
Suggested Citation: Suggested Citation