What drives bank liquidity creation? The interaction of monetary policy and strategic scope

Abstract

The research investigates how the marginal influence of monetary policy on the expansion of liquidity creation changes depending on the strategic scope of banks. Through a sample of Vietnamese commercial banks between 2007 and 2019, we estimate measures of liquidity creation that consider all banking items and build up various monetary policy indicators. Empirical regressions are achieved with the dynamic generalized method of moments (GMM) estimator that is fitted to tackle the endogeneity issue. The study confirms the existence of the bank liquidity creation channel, i.e., an easing monetary policy boosts the banks' liquidity creation ability, both when the central bank reduces interest rates and injects more capital into the market. For banks with a strategic scope that relies more on non-interest revenues or diversifies more into various banking segments, the relationship between monetary policy and the generation of bank liquidity is strengthened when the central bank adjusts interest rates but mitigated if it changes the money supply using quantitative-based monetary tools. This paper expands the literature stream on monetary policy's liquidity creation channel, which is essential to the economy but has been little explored, by shedding light on the moderating role of bank income. Additionally, this study employs many policy indicators based on interest- and non-interest-rate tools to avoid misleading conclusions on the policy stance.