Bank Liquidity Management and Bank Capital Shocks

43 Pages Posted: 17 Jul 2017 Last revised: 3 Aug 2017

See all articles by Robert DeYoung

Robert DeYoung

University of Kansas School of Business

Isabelle Distinguin

Université de Limoges, LAPE

Amine Tarazi

University of Limoges - Faculty of Law and Economic Science

Date Written: June 15, 2017

Abstract

The Basel III Accord imposes minimum liquidity standards on bank balance sheets that are already constrained by minimum capital standards. It is not clear whether or how banks’ behaviors will change in this new joint-constraint regime. To gain some insight, we study the balance sheet liquidity behavior of U.S. banking companies in response to negative equity capital shocks prior to the implementation of Basel III. Our 1998-2012 data indicate that banks treated regulatory capital and balance sheet liquidity (e.g., net stable funding ratios, core deposits-to-loans, liquid assets-to-assets) as substitutes rather than complements. This main finding is limited to so-called ‘community banks’ with assets less than $1 billion; equity capital and liquidity were neither substitutes nor complements at larger banks. In the course of rebuilding their capital ratios, shocked community banks substituted away from loans and loan commitments and reduced their dividend payouts, actions that resulted in greater balance sheet liquidity. Thus, in the state of nature that has traditionally most concerned bank regulators (i.e., stress to bank equity capital), community banks increase their liquidity buffers. Given that these lenders do not pose systemic risk, and that they have historically exceeded the Basel III liquidity minimums by wide margins, our findings suggest that imposing minimum liquidity thresholds on small banks will likely yield little prudential benefit.

Keywords: Bank Capital, Bank Liquidity, Basel III, Lending, Net Stable Funding Ratio

JEL Classification: G21, G28

Suggested Citation

DeYoung, Robert and Distinguin, Isabelle and Tarazi, Amine, Bank Liquidity Management and Bank Capital Shocks (June 15, 2017). 30th Australasian Finance and Banking Conference 2017. Available at SSRN: https://ssrn.com/abstract=2999662 or http://dx.doi.org/10.2139/ssrn.2999662

Robert DeYoung

University of Kansas School of Business ( email )

Capitol Federal Hall
1654 Naismith Drive
Lawrence, KS 66045
United States
785-864-1806 (Phone)

Isabelle Distinguin

Université de Limoges, LAPE ( email )

5 rue Félix Eboué BP3127
LIMOGES, 87031
France

Amine Tarazi (Contact Author)

University of Limoges - Faculty of Law and Economic Science ( email )

5 rue Felix Eboue
Limoges, 87000
France

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