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Journal of Financial Services Research

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01-06-2014

Bank Capital and Liquidity Creation: Granger-Causality Evidence

Authors: Roman Horváth, Jakub Seidler, Laurent Weill

Published in: Journal of Financial Services Research | Issue 3/2014

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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.

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For instance, Bankscope does not provide the disaggregation of loans by category or by maturity for the vast majority of banks, which is of course needed for the computation of liquidity creation measures. Moreover, even within countries, the classifications of demand deposits, savings deposits, and time deposits are not consistent across banks.

Note that a large share of foreign bank ownership is common in Central and Eastern European countries. In addition to the Czech Republic, in Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Estonia, FYR Macedonia, Georgia, Hungary, Lithuania, Montenegro, Romania, and Slovakia foreign banks own greater than 80 % of banks’ assets. These figures come from EBRD Structural Change Indicators.

See also Harding et al. (2013) on the effect on banks’ capital requirements and deposit insurance on banks’ capital structure.

In contrast to their paper, we use “fully mat fat” and “fully mat nonfat” measures, that is, we classify all items (not just loans) by the remaining maturity.

Twelve lags are used in the robustness check, please see section 4.3.

A building society is a special type of bank that provides home loans to households under specific conditions given in Act No. 96/1993 Coll., on Building Savings Schemes and State Support for Building Savings Schemes and its later amendments. Based on the volume of total assets, 4 building societies would be classified as medium-sized banks and one as a small bank.

The results in Tables 5 and 6 are reported with macro controls. Results without macro controls are available upon request.

See Brewer et al. (2008) on why the capital ratios vary across countries.

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Title: Bank Capital and Liquidity Creation: Granger-Causality Evidence
Authors: Roman Horváth
Jakub Seidler
Laurent Weill
Publication date: 01-06-2014
Publisher: Springer US
Published in: Journal of Financial Services Research / Issue 3/2014
Print ISSN: 0920-8550
Electronic ISSN: 1573-0735
DOI: https://doi.org/10.1007/s10693-013-0164-4