Bank Liquidity Creation, Regulations, and Credit Risk

Abstract

AbstractThis study employs bank‐level data covering 3007 individual banks (commercial, savings, and others) in 27 Asian countries to investigate the determinants of bank liquidity creation, considering four conditional factors over the period 1999–2013: credit risk, deposit insurance, financial market regulations, and bank reforms. Bank liquidity creation is shown to be statistically and economically significantly positively related to real economic output, as well as illiquid assets and core deposits. Larger banks increase their liquid assets ratio, but decrease their credit commitment. Countries implementing an explicit deposit insurance scheme may lead to moral hazard and excessive bank risk taking. If supervisory authorities can force a bank to change its internal organizational structure, or have more power to take legal action against external auditors for negligence, or increase capital requirements, then banks generally reduce their lending activities. Nevertheless, larger banks are able to increase liquid assets and lending to those countries with stricter financial regulations.