Liquidity Creation Research Articles

Climate policy uncertainty and bank liquidity creation

This paper examines the influence of Climate Policy Uncertainty (CPU) on the liquidity creation of banks in China. Through an empirical analysis of data from 387 commercial banks in China, our findings indicate that CPU notably diminishes bank liquidity creation. The effect is predominantly observed on the asset side of liquidity, indicating a reduction in credit supply by banks as a response to increased CPU, while the impact on liability side liquidity appears negligible. The study further uncovers significant regional variations in the vulnerability of banks to CPU, highlighting that foreign banks, eastern and middle banks are disproportionately affected.

The beneficial effect of common ownership: Evidence from bank liquidity creation

We argue a positive association between common ownership and liquidity creation because common ownership increases risk-absorption capacity through higher profit margins, greater equity capital, and improved disclosure quality. Accordingly, we find solid evidence that banks with greater common ownership create 3.56%–4.54% more liquidity. The beneficial effect on liquidity creation is dominant for banks with high risk-absorption capacities, enhanced disclosure quality, low competition, greater long-term shareholdings, and low performance-sensitive managerial incentives, substantiating our theoretical conjectures and establishing five significant channels. Finally, we show that banks have incentive to create more liquidity when they have significant co-ownerships among themselves. Our main findings remain robust to multiple proxies, alternative specifications, and three methods to address endogeneity concerns – difference-in-differences based on the Blackrock–Barclays Global Investors merger in 2009, two-stage least squares analysis with instrumental variables based on Russell 2000 index inclusion, and propensity score matching.

The level of digitalization in Commercial banks and bank liquidity creation

This paper takes all banking enterprises among Chinese listed companies as the research sample and examines the impact of the level of digitalization in commercial banks on bank liquidity creation through constructing an empirical econometric model. The research results show that the level of digitalization in commercial banks can significantly enhance the level of bank liquidity creation. Additionally, the results of heterogeneity tests indicate that the effect of commercial banks' digitalization level on the enhancement of bank liquidity creation varies with the size of the commercial banks and the degree of integration between industry and finance.

How does competition influence liquidity creation? Exploring credit risk, foreign banks, and crisis

Contributing to the past literature related on how bank competition affects the creation of liquidity, this research explores a comprehensive dataset of 43 European countries for a total of 13,487 individual banks spanning the period 2005–2020. We evaluate the influences of credit risk, foreign banks, and crisis in the liquidity creation and competition nexus, presenting results that greater competition lowers fragile banks’ incentives and/or risk absorption capacity and increases unprofitable liquidity creation, thus supporting the fragility channel hypothesis. Nevertheless, there is an opposite competition causality for commercial banks and financial holding companies. Commercials banks as well as holding companies are generally larger in terms of assets than other financial institutions and hence may have more market power and capacity to lend more, supporting the price channel hypothesis. Credit risk, foreign banks, and crisis exhibit concrete roles in the liquidity creation and competition nexus. Lastly, we discuss policy implications.

Bank liquidity creation, loan concentration and liquidity risk: a comparative analysis of dual banking system

Purpose Keeping in view the robust growth of Islamic banking around the globe, this study aims to comparatively analyze the association between liquidity creation and liquidity risk for Islamic banks (IBANs) and conventional banks (CBANs) in Pakistan and Malaysia over a period of 2004–2021. The moderating role of bank loan concentration on the aforementioned relationship is also studied. Design/methodology/approach Regression estimation methods such as fixed effect, random effect and generalized least square are deployed for obtaining results. Liquidity creation Burger Bouwman measure (cat fat and noncat fat) and Basel-III liquidity risk measure (liquidity coverage ratio) are also used. Findings The results give us insight that liquidity creation is positively and significantly related to liquidity risk in both IBANs and CBANs of Pakistan and Malaysia. This relationship has been moderated negatively (reversed) and significantly by credit concentration showing the importance of risk management and loan portfolio concentration. Practical implications It is analyzed that during the process of liquidity creation, IBANs in Pakistan faced more liquidity risk for both on and off-balance sheet transactions in the presence of moderation of loan concentration than IBANs in Malaysia necessitating strategic policy-making for important aspects of liquidity risk management and loan concentration while creating liquidity. Originality/value Such studies comparing IBANs and CBANs comparison keeping in view liquidity creation, liquidity risk and loan concentration are either limited or nonexistent.

A liquidity preference approach to nonfinancial corporate liquid asset holdings

This paper examines the long-run pattern of the U.S. nonfinancial corporate sector’s liquid financial asset holdings in the period from 1951 to 2018. My approach to examining this pattern builds from the banks’ liquidity preference theory put forward in Keynes’ 1937 papers, as well as Minsky’s 1957 paper discussing the role of financial innovation in the banks’ management of liquidity preference. I argue that financial intermediaries affect nonfinancial corporations’ liquid asset holdings through two primary money creation channels: (1) banks’ commercial and industrial loans advanced to nonfinancial corporations and (2) the liquidity premium of financial intermediaries, which can be measured by the interest rate spread in the intermediaries’ liabilities markets. Through theoretical and empirical exercises, I find that these two endogenous liquidity creation channels have been the important factors accounting for liquid asset accumulation by the nonfinancial corporate sector. Overall, my results suggest that financial innovations, structural changes of the U.S. financial system, and financial intermediaries’ liquidity premium could contribute to our understanding of the shift in nonfinancial corporations’ asset portfolio composition in favor of liquid financial assets.

Increasing returns to scale and financial fragility

How do liquidity creation and financial fragility depend on increasing returns to scale? We study this question in a version of the Diamond and Dybvig (1983) model with limited commitment. We show that while a higher minimum scale generally lowers welfare since it makes the investment technology more restrictive, there exhibits a non-monotonic relationship between the degree of instability and size thresholds. In particular, to reap the benefits of scale economies, the bank facing somewhat higher scale cutoffs may issue liabilities prudently where such cautious behavior ameliorates depositors’ incentive to panic. Nevertheless, a relatively large minimum scale is not always associated with lower degrees of fragility in the sense that the bank facing medium size thresholds is most vulnerable to a crisis. Such findings indicate that failing to account for scale economies in banking activity leaves a significant void in policy debates regarding the stability of the financial system.

Bank capital and liquidity creation in Sub-Saharan Africa: the role of quality institutions

PurposeThis study investigates the relationship between bank capital and liquidity creation and further examines the effect that institutional quality has on this relationship in Sub-Saharan Africa (SSA).Design/methodology/approachThe data comprise 41 universal banks in nine SSA countries from 2010 to 2022. The study employs the two-step system generalized methods of moments and further uses alternative estimators such as the fixed-effect and two-stage least squares methods.FindingsThe empirical results show that bank capital has a direct positive and significant effect on liquidity creation. In addition, the positive effect of bank capital on liquidity creation is enhanced, particularly in a strong institutional environment. The results imply that nonconstraining capital regulatory policies bolster bank solvency, improve risk-absorption capacity and increase liquidity creation.Practical implicationsThis study has several policy implications. First, it provides empirical evidence on the position of banks in SSA on the financial fragility and risk-absorption hypothesis of bank capital and liquidity creation debates. This study shows that the effect of bank capital on liquidity creation in SSA countries is positive and supports the risk-absorption hypothesis. Second, this study highlights that a country's quality institutions can complement bank capital to increase liquidity creation. In addition, this study highlights that nonconstraining capital regulatory policies will bolster bank solvency, improve risk-absorption capacity and increase liquidity creation.Originality/valueThe novelty of this study is that it introduces the country's quality institutional environment into bank capital and liquidity creation links for the first time in SSA.

Capital adequacy, competition and liquidity creation of banks; evidence from Kenya

PurposeThe study seeks to evaluate the effect of capital adequacy and competition on the liquidity creation of Kenyan commercial banks.Design/methodology/approachUnbalanced panel data from 36 Kenyan commercial banks with licenses from 2001 to 2020 is used in the study. The generalized method of moments (GMM), a two-step system, is employed in the investigation. To increase the robustness and prevent erroneous findings, serial correlation tests and instrumental validity analyses are used. The methodology developed by Berger and Bouwman (2009) is used to estimate the commercial banks' levels of liquidity creation.FindingsThe study supports the financial fragility-crowding out hypothesis by finding a significant negative effect of capital adequacy on the liquidity creation of commercial banks. The research also identifies a significant inverse relationship between competition and liquidity creation, depicting competition's value-destroying effect.Practical implicationsA trade-off exists between capital adequacy and liquidity creation, which must be carefully evaluated as changes in capital requirements are considered. The value-destroying effect of competition on liquidity creation presents a case for policy geared toward consolidating banks' operations through possible mergers and acquisitions.Originality/valueTo the best of the authors' knowledge, this is the first study to empirically offer evidence concurrently on the effect of competition and capital adequacy on the liquidity creation of commercial banks in a developing economy such as Kenya. Additionally, the authors employ a novel measure of competition at the firm level.

Fintech regulation and bank liquidity creation: Evidence from China

Fintech regulation serves as a vital signal for prudential regulation, helping to mitigate market failures caused by Fintech innovation. Using China's 2016 Implementation Plan for the Specific Rectification of Internet Financial Risks, we employ a difference-in-differences identification strategy to investigate the impact of Fintech regulation on banks' liquidity creation. Our paper reveals the following findings: Fintech regulation triggers deposit inflows and lowers reliance on interbank funds, strengthening banks' deposit franchises and risk-transforming functions. By enhancing banks' ability to convert liquid liabilities into illiquid assets, Fintech regulation facilitates liquidity creation, which is crucial for the smooth functioning of the financial system. After controlling for other major regulatory and government-led initiatives, the incremental effect of Fintech regulation on Chinese banking liquidity creation is still apparent. By demonstrating the benefits of Fintech regulation, our research provides a valuable reference for policymakers.

Examining the impact of liquidity creation on bank stability in the Asia Pacific region: Do ESG disclosures play a moderating role?

The global financial crisis reignited concerns regarding the stability and sustainability of banks. Since liquidity creation (LC) is a core output of banks, we examine if the nexus between LC and bank stability is conditional on ESG (environmental, social, and governance) disclosure by banks. Our sample comprises 178 commercial banks (1568 observations) during the period 2010–2019 in the Asia-Pacific region. Using a two-step system GMM estimation, our results document a positive impact of LC on bank stability. Additionally, ESG disclosures positively moderate the stability effect of LC, i.e., higher LC is associated with significantly more enhancement in bank stability for banks that have a higher disclosure of ESG scores compared to banks that have a moderate disclosure. Furthermore, we also provide evidence of variation in the moderating role of ESG disclosures in advanced and emerging economies. Overall, our results recommend that integrating ESG practices into banks' internal processes improves their financial soundness. Additionally, blanket implementation of liquidity regulations might be detrimental to banks’ stability.

The effect of banks’ cost efficiency and competition on liquidity creation

This study examines the role of a bank’s cost efficiency and competition when creating liquidity. It also investigates the different abilities to create liquidity between conventional banks and Islamic banks. This study employs data from annual reports for 117 banks, including 103 conventional banks and 14 Islamic banks from the Association of Southeast Asian Nations 4 (ASEAN-4). Using the dynamic panel regression with the GMM system, this study finds that cost-efficient banks have a higher ability to create liquidity, while high banking competition deteriorates that ability. However, these effects decrease as banks manage their costs more efficiently. The findings imply that banks’ ability to create liquidity is impacted by their market power to win the competition. Additionally, this study found that Islamic banks create more liquidity than conventional banks. This phenomenon indicates that by being more focused on activities using on-balance sheet items, Islamic banks are spared from risky off-balance sheet commitments. Furthermore, efficient banks are more able to generate liquidity in competitive markets.

ESG engagement, country-level political risk and bank liquidity creation

This study explores the influence of banks' environmental, social, and governance (ESG) performance and country-level risk factors on liquidity creation. Utilizing a distinctive sample of 2103 bank-year observations from 2000 to 2020 in Asia, the study finds that banks' ESG performance exerts a positive impact on bank liquidity creation. Furthermore, this relationship is more prominent in countries with high geopolitical risk and corruption risk and low levels of democratization. To address endogeneity concerns, a two-stage least squares regression is employed using two instrumental variables, and the findings remain robust. These findings have practical implications for banks and policymakers to consider a country's political risk when promoting ESG activities and facilitating liquidity creation.

Bank capital and liquidity creation: Evidence from the Russian experience

In this paper we examine the relationship between regulatory bank capital and liquidity creation. We test the “financial fragility‐crowding out hypothesis” and the “risk absorption hypothesis” on the sample of 885 Russian banks over the 2010–2019 period. Inspired by Berger and Bouwmanʼs (2009) approach, we develop a liquidity creation measure that simultaneously considers the category and maturity of secondary accounts. After conducting several robustness checks, we report that bank capital is negatively related to liquidity creation which supports the “financial fragility‐crowding out hypothesis”. We also show that this relationship is independent of the bank size and the economic cycle. Our findings suggest that the Central Bank of Russia faces a trade‐off between financial stability and liquidity creation by the banking system, as tougher regulatory capital requirements decrease banks’ abilities to finance the real sector of the economy.

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

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.

FinTech adoption in banks and their liquidity creation

Utilizing an innovative financial technology (FinTech) index based on media sources, we analyse the effects of FinTech adoption on bank liquidity creation for a sample of the top 300 United States banks from Q1 2015 to Q2 2021. Our findings reveal a consistent negative association between FinTech adoption and bank liquidity creation, even during the coronavirus disease (COVID-19) pandemic. This relationship remains robust after conducting multiple rigorous tests including propensity score matching and difference-in-differences tests to address endogeneity problems. Overall, these results underscore the transformative influence of FinTech on fundamental liquidity creation function within traditional banking.

Highlighting Factors Influencing Financial Innovation

Objective: The objective of this research is to examine the factors influencing financial innovation in companies operating within the capital market. Methodology: The study employs a structural equation modeling (SEM) approach to test the hypothesized relationships. Data were collected through questionnaires from a sample of 70 experts in the field. Confirmatory factor analysis (CFA) was used to validate the constructs, and the model was assessed for fit and reliability using various indices such as Average Variance Extracted (AVE), Cronbach's alpha, and Composite Reliability (CR). Findings: The results indicate that all proposed paths are significant. Causal conditions are found to have a meaningful relationship with financial innovation through financial development phases, liquidity creation, risk management tools, and other factors. The central phenomenon significantly impacts contextual conditions such as GDP growth, regulatory changes, and organizational creativity. Additionally, intervening conditions (risk coverage, commodity-based financing) and strategies (use of Islamic financial instruments, management capability) also significantly influence contextual conditions. Lastly, contextual conditions have a significant effect on the outcomes, including social trust and financial performance. Conclusion: The study concludes that the identified factors significantly influence financial innovation in the capital market. These findings are consistent with previous research, particularly aligning with the results of Abdullah et al. (2022). The research highlights the importance of understanding the relationships between these factors to foster financial innovation effectively.

A Panorama of Liquidity Creation in Turkish Banking Industry: Highlights, Determinants and Consequences

A Panorama of Liquidity Creation in Turkish Banking Industry: Highlights, Determinants and Consequences

The impact of liquidity creation on bankruptcy risk: evidence from banks listed on Vietnam Stock Market

The impact of liquidity creation on bankruptcy risk: evidence from banks listed on Vietnam Stock Market

Market Maker of First Resort – The People’s Bank of China and the Rise of Market-Based Banking

ABSTRACT Drawing conceptually upon the literature on critical macro-finance and market-based banking, this article investigates the People’s Bank of China’s (PBC) role in transforming China’s financial system. By analysing regulatory and monetary policy in the context of the party-state’s financial reform agenda and against the background of structural changes in liquidity creation, it shows how the PBC has created a bond market from shadow banking. To this end, the PBC makes and governs through financial markets by targeting the liquidity of interbank collateral through unconventional monetary policies, that is, by expanding its own balance sheet. By developing an interbank bond market, the PBC has restored its control over credit creation and financial stability previously lost to shadow banking, however, at the price of inserting itself more tightly into political economic constraints created by the nexus of liquidity and growth.