Too Big to Care, Too Small to Matter: Macrofinancial Policy and Bank Liquidity Creation (original) (raw)
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To the best of our knowledge, this is the first study to estimate the causal effect of liquidity regulation on bank balance sheets. It takes advantage of the heterogeneous implementation of new liquidity regulation by the UK Financial Services Authority (FSA) in 2010. This new regulation required a subset of banks operating in the UK to hold a sufficient stock of high quality liquid assets (HQLA) to withstand two scenarios of stressed funding conditions. We find that banks increased the share of HQLA and funding from more stable UK non-financial deposits while reducing the share of short-term intra-financial loans and short-term wholesale funding to meet tighter liquidity requirements. We do not find evidence that the tightening of liquidity regulation caused banks to shrink their bank balance sheets, nor reduce the amount of lending to the non-financial sector. In addition we do not find evidence that banks increased the average interest rates on loans to non-financials.
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Relying on theories in which bank loans create deposits-a process we call "funding liquidity creation"-we measure how much funding liquidity the U.S. banking system creates. Private money creation by banks enables lending to not be constrained by the supply of cash deposits. During the 2001-2020 period, 92 percent of bank deposits were due to funding liquidity creation, and during 2011-2020 funding liquidity creation averaged $10.7 trillion per year, or 57 percent of GDP. Using natural disasters data, we provide causal evidence that better-capitalized banks create more funding liquidity and lend more even during times when cash deposit balances are falling.
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Journal of Money, Credit and Banking, 2017
Bank regulation has increasingly focused on capital requirements as the primary means of ensuring the "safety and soundness" of the banking system. We evaluate this policy approach by providing a theory of bank capital. Bank capital is beneficial because it reduces the chance of privately and socially costly bank failure. But it is both privately and socially costly because a system-wide increase in bank capital reduces the aggregate amount of bank deposits, which are an efficient medium of exchange, forcing consumers to hold more information-sensitive bank equity, which is a poor liquidity hedge. Recessions increase the risk and thus the information-sensitivity of bank equity, increasing the liquidity-related costs of additional bank capital. As a result, welfare-maximizing bank regulators may engage in "forbearance"-that is, they may optimally renege on previously tough policies. Private incentives to increase capital are even smaller than social incentives, which may further limit regulators' ability to raise capital standards. Social and private reluctance to increase capital in a recession may in turn cause a "credit crunch." JEL: G21, G28 Some of the ideas in this paper originated in an earlier draft entitled "Bank Capital Regulation in General Equilibrium." We are grateful to Ross Levine and Thorsten Beck for providing data, and to William
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SSRN Electronic Journal, 2000
During times of bank distress, authorities often engage in regulatory interventions and provide capital support to reduce bank risk taking. An unintended effect of such actions may be a reduction in bank liquidity creation, with possible adverse consequences for the economy as a whole. This paper tests hypotheses regarding the effects of regulatory interventions and capital support on bank risk taking and liquidity creation using a unique dataset over the period 1999-2009. We find that both types of actions are generally associated with statistically significant reductions in risk taking and liquidity creation in the short run and long run. While the effects of regulatory interventions are also economically significant, the effects of capital support are only economically significant in the long run. Thus, both types of actions have important intended and unintended consequences with implications for policymakers.
SSRN Electronic Journal, 2018
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High Liquidity Creation and Systemic Risk in the U.S. Banking Sector
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Bank regulatory capital and liquidity: Evidence from US and European publicly traded banks
Journal of Banking & Finance, 2013
The theory of financial intermediation highlights various channels through which capital and liquidity are interrelated. Using a simultaneous equations framework, we investigate the relationship between bank regulatory capital and bank liquidity measured from on-balance sheet positions for European and U.S. publicly traded commercial banks. Previous research studying the determinants of bank capital buffer has neglected the role of liquidity. On the whole, we find that banks decrease their regulatory capital ratios when they face higher illiquidity as defined in the Basel III accords or when they create more liquidity as measured by Berger and Bouwman (2009). However, considering other measures of illiquidity that focus more closely on core deposits in the United States, our results show that small banks strengthen their solvency standards when they are exposed to higher illiquidity. Our empirical investigation supports the need to implement minimum liquidity ratios concomitant to capital ratios, as stressed by the Basel Committee; however, our findings also shed light on the need to further clarify how to define and measure illiquidity and also on how to regulate large banking institutions, which behave differently than smaller ones.
IMF Working Papers, 2020
Whether and to what extent tougher bank regulation weighs on economic growth is an open empirical question. Using data from 28 manufacturing industries in 50 countries, we explore the extent to which cross-country differences in bank liquidity and capital levels were related to differences in sectoral activity around the period of the global financial crisis. We find that industries which are more dependent on external finance, in countries where banks had higher liquidity and capital ratios, performed relatively better during the crisis, with regard to investment rates and the creation of new enterprises. This relationship, however, exists only for bank-based systems and emerging market economies. In the pre-crisis period, we find only a marginal link to bank capital. These findings survive a battery of robustness checks and provide some solid support for the tighter prudential measures introduced under Basel III.
Journal of Financial Stability, 2020
Using U.S. bank holding company data, we study the impact of the crisis liquidity programs initiated by the U.S. Federal Reserve on bank-specific information production. We find empirical evidence that following the receipt of liquidity support there was a pervasive decrease in bank stock price informativeness that increased market synchronicity and crash risk. Our findings further suggest that these effects are mainly driven by bank participation in the Discount Window (DW) and Term Auction Facility (TAF) programs. On the bright side, we confirm that the liquidity programs served their purpose in targeting and supporting illiquid banks with low core stable funding sources through the crisis.
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SSRN Electronic Journal, 2020
We study the effects of the US Federal Reserve's large-scale asset purchase programs during 2008-2014 on bank liquidity creation. Banks create liquidity when they transform the liquid reserves resulted from quantitative easing (QE) into illiquid assets. As the composition of banks' loan portfolio affects the amount of liquidity it creates, the impact of quantitative easing on liquidity creation is not a priori clear. Using a difference-indifference identification strategy, we find that banks more affected by the policy increased lending relative to those less affected, mainly during the first and third round of QE. However, we only find a strong effect of the policy on liquidity creation during the third round of QE. This points to a weaker impact on the real economy during the first two rounds, when more exposed banks transformed the reserves created through QE into less illiquid assets, such as real estate mortgages.