Banks' Capital and Liquidity Creation: Granger Causality Evidence

Roman Horvath, Jakub Seidler and Laurent Weill

Working Papers from Czech National Bank, Research and Statistics Department

Abstract: This paper examines the relation between banks' capital and liquidity creation. This issue is of interest to determine the potential impact of higher capital requirements for banks on their liquidity creation, which may have particular importance with new Basel III reform demanding from banks higher capital. We perform Granger-causality tests in a dynamic GMM panel estimator framework on an exhaustive dataset of Czech banks from 2000 to 2010. We observe a strong expansion of liquidity creation during the full period, which was slowed by the financial crisis, and was mainly driven by large banks. We show that capital is found to negatively Granger-cause liquidity creation but also observe that liquidity creation Granger-causes capital reduction. These findings support the view that Basel III reforms demanding higher capital can reduce liquidity creation, but also that greater liquidity creation can have a detrimental impact by reducing bank solvency. We thus show that there might be a trade-off between the benefits of financial stability induced by stronger capital requirements and those of increased liquidity creation of banking sector.

Keywords: Bank capital; liquidity creation. (search for similar items in EconPapers)
Date: 2012-06
New Economics Papers: this item is included in nep-ban and nep-cba
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Citations: View citations in EconPapers (9)

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https://www.cnb.cz/export/sites/cnb/en/economic-re ... wp/cnbwp_2012_05.pdf

Related works:
Journal Article: Bank Capital and Liquidity Creation: Granger-Causality Evidence (2014)
Working Paper: Bank capital and liquidity creation: Granger-causality evidence (2012)
Working Paper: Bank Capital and Liquidity Creation: Granger Causality Evidence (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:cnb:wpaper:2012/05

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