Liquidity indicators, early warning signals in banks, and financial crises

Ting-Hsuan Chen, Chien-Chiang Lee () and Chung-Hua Shen

The North American Journal of Economics and Finance, 2022, vol. 62, issue C

Abstract: This research compares the performance of three liquidity indicators, namely liquidity ratio (LiqR), liquidity creation (LiqC) and net stable funding difference (NSFD), for sending early warning signals for distressed banks. Recent evidence has shown that LiqR appears incapable of measuring the liquidity condition of banks. However, LiqC and NSFD have not yet been fully examined. Thus, which indicator is more useful in an early warning model becomes an interesting issue. We classify distressed banks as banks that have experienced a bank run, bailout, or failure. Sample data are collected from the United States and the European Union from before and after the financial crisis. We then estimate model predictive value using the sample before the crisis to predict liquidity shortages. Evidence shows that the academic (LiqC) and officially recommended indicators (NSFD) outperform LiqR as early warning signals. Furthermore, LiqC performs best when banks actively engage in income diversification but not fund diversification. Therefore, a well income-diversified bank with high LiqC tends to have high distress probability in the next period.

Keywords: Liquidity indicators; Early warning signal; Banks; Financial crisis; Distress probability (search for similar items in EconPapers)
JEL-codes: G21 G33 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:62:y:2022:i:c:s1062940822000821

DOI: 10.1016/j.najef.2022.101732

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