The impact of quantitative easing on liquidity creation

Supriya Kapoor,Oana Peia

doi:10.1016/j.jbankfin.2020.105998

Abstract

• We study the impact of the Fed’s three rounds of QE on bank liquidity creation. • Banks create liquidity by financing illiquid assets with liquid liabilities. • We use a sample of US banks over 2006-14 and a difference-in-difference methodology. • Banks more exposed to QE increased lending during the first and third round of QE. • Liquidity creation among treated banks was higher only during the last round of QE. We study the effects of the US Federal Reserve’s large-scale asset purchase programs during 2008–2014 on bank liquidity creation. Banks create liquidity when they transform the liquid reserves resulted from quantitative easing (QE) into illiquid assets. As the composition of banks’ loan portfolio affects the amount of liquidity it creates, the impact of quantitative easing on liquidity creation is not a priori clear. Using a difference-in-difference identification strategy, we find that banks more affected by the policy increased lending relative to those less affected, mainly during the first and third round of QE. However, we only find a strong effect of the policy on liquidity creation during the third round of QE. This points to a weaker impact on the real economy during the first two rounds, when more exposed banks transformed the reserves created through QE into less illiquid assets, such as real estate mortgages.

Highlights

Starting with the 2008-09 Global Financial Crisis, a growing number of central banks have included large-scale asset purchase programs (LSAPs) in their toolkit of unconventional monetary policies
We first revisit the impact of quantitative easing (QE) on bank lending for our sample of bank holding corporations (BHCs)
We study the effects of large scale asset purchases on bank liquidity creation

Summary

Introduction

Starting with the 2008-09 Global Financial Crisis, a growing number of central banks have included large-scale asset purchase programs (LSAPs) in their toolkit of unconventional monetary policies. Rodnyansky & Darmouni (2017) and Luck & Zimmermann (2020) find that banks increased overall lending after the first and third rounds of quantitative easing, with the first corresponding to mostly an increase in mortgage origination, while the third round to an increase in both real-estate, as well as commercial and industrial loans. Chakraborty et al (2019), on the other hand, find that the increase in mortgage lending crowded-out the origination of commercial loans, the latter decreasing as a result of the Fed’s asset purchase programs Quantitative easing can lead to an increase in credit supply through a classical bank lending channel, as banks gain new reserves and/or customer deposits, which are a relatively cheaper source of funding, and could result in a shift in the loan supply (Kashyap & Stein 2000, Butt et al 2014, Kandrac & Schlusche 2017). Yet, evidence on the impact of QE on bank lending is more confounded. Rodnyansky & Darmouni (2017) and Luck & Zimmermann (2020) find that banks increased overall lending after the first and third rounds of quantitative easing, with the first corresponding to mostly an increase in mortgage origination, while the third round to an increase in both real-estate, as well as commercial and industrial loans. Chakraborty et al (2019), on the other hand, find that the increase in mortgage lending crowded-out the origination of commercial loans, the latter decreasing as a result of the Fed’s asset purchase programs

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