Journal of Financial Services Research

, Volume 45, Issue 3, pp 341–361

Bank Capital and Liquidity Creation: Granger-Causality Evidence

Article

Abstract

We examine the relation between capital and liquidity creation. This issue is interesting because of the potential impact on liquidity creation from tighter capital requirements such as those in Basel III. We perform Granger-causality tests in a dynamic GMM panel estimator framework on an exhaustive data set of Czech banks, which mainly includes small banks from 2000 to 2010. We observe a strong expansion in liquidity creation until the financial crisis that was mainly driven by large banks. We show that capital negatively Granger-causes liquidity creation in this industry, where majority of banks are small. But we also observe that liquidity creation Granger-causes a reduction in capital. These findings support the view that Basel III can reduce liquidity creation, but also that greater liquidity creation can reduce banks’ solvency. Thus, we show that this reverse causality generates a trade-off between the benefits of financial stability induced by stronger capital requirements and the benefits of increased liquidity creation.

Keywords

Bank capital Liquidity creation 

JEL Classification

G21 G28 

Copyright information

© Springer Science+Business Media New York 2013

Authors and Affiliations

  1. 1.Charles UniversityPragueCzech Republic
  2. 2.IOSRegensburgGermany
  3. 3.Czech National Bank and Charles UniversityPragueCzech Republic
  4. 4.EM Strasbourg Business SchoolUniversity of StrasbourgStrasbourgFrance

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