Bank Capital and Liquidity Creation: Granger Causality Evidence

Roman Horvath, Jakub Seidler and Laurent Weill

No 318, Working Papers from Leibniz Institut für Ost- und Südosteuropaforschung (Institute for East and Southeast European Studies)

Abstract: This paper examines the relationship between capital and liquidity creation. This issue is of interest to determine the potential impact of tighter capital requirements such as those involved in Basel III reforms on liquidity creation. 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 can reduce liquidity creation, but also that greater liquidity creation can have a detrimental impact by reducing bank solvency. We thus show that there is a trade-off between the benefits of financial stability induced by stronger capital requirements and those of increased liquidity creation.

Keywords: bank capital; liquidity creation (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Pages: 40
Date: 2012-07
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Citations: View citations in EconPapers (19)

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Related works:
Journal Article: Bank Capital and Liquidity Creation: Granger-Causality Evidence (2014)
Working Paper: Banks' Capital and Liquidity Creation: Granger Causality Evidence (2012)
Working Paper: Bank capital and liquidity creation: Granger-causality evidence (2012)
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