Bank Liquidity Creation and Technological Innovation

Abstract

This paper examines the association between bank liquidity creation and technological innovation. Using a comprehensive measure of bank output, I find that bank liquidity creation stymies technological innovation, measured by patent-based criteria. This is robust to using the difference-in-differences and instrumental variable approach, and several other robustness checks. Further analysis reveals that small banks are more likely to promote firm innovation, and bank liquidity creation enhances innovation by firms that have above-median asset tangibility. Overall, the results in this paper provide important insight into the prospect of banking and finance and suggest that the role of banks in promoting innovation is limited during the transition to the knowledge-based economy.

Keywords: liquidity creation; financing; banks; innovation

JEL Classification: G20, G21, G28, G32, O31