Abstract
Banks play a central role in creating liquidity for the economy by financing illiquid assets with liquid liabilities. This paper examines the effect of accounting restatements on bank liquidity creation. Using a difference-in-differences research design, I show that restatements are associated with a significant reduction in liquidity creation. This effect derives mainly from a shift in banks’ asset composition away from illiquid assets and toward liquid assets. Further analysis reveals that restatements affect liquidity creation through supervisory enforcement actions and unravelling of risk exposures accumulated in the misreporting period. Government deposit insurance blunts the effect of an information asymmetry channel.
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