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22-09-2024 | Original Research

Bank performance and liquidity management

Authors: I-Ju Chen, Hsiangping Tsai, Yan-Shing Chen, Wei Chih Lin, Ting-Yu Li

Published in: Review of Quantitative Finance and Accounting

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Abstract

This paper investigates bank liquidity management and its effect on bank performance. Commercial bank’s balance the tradeoff between holding liquid assets and investing in risky assets to maximize profits. Holding more liquid assets lowers the liquidity risk of banks, but it also increases their operation costs and likely lowers their profits. Therefore, we hypothesize that a bank’s liquidity management policy matters for bank performance. We analyze bank data from Call Reports from 1990 to 2020. We compute a comprehensive liquidity measures and estimate the adequate liquidity level for each bank as the basis for evaluating the liquidity management of a bank. We show that banks that maintain an adequate liquidity ratio tend to experience better operating performance, greater stability, and lower bankruptcy risk. We also investigate the effect of bank liquidity management under different economic conditions. Our study highlights the importance of bank liquidity management.

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Appendix
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Footnotes
1
A positive number shows that a bank holds more liquid assets than is theoretically estimated as necessary, perhaps because it wishes to lower its liquidity risks. A negative number shows a bank holds less liquid assets than is theoretically estimated as necessary, perhaps because it underestimates the liquidity risks present or determines it is capable of dealing with the risks.
 
2
The Gramm–Leach–Bliley Act, also known as the Financial Services Modernization Act of 1999, expands the range of bank activities by removing barriers in the market among commercial banks, securities companies, and insurance companies. Before the Gramm–Leach–Bliley Act, financial institutions were prohibited from acting as any combination of an investment bank, a commercial bank, and an insurance company. With the passage of the Gramm–Leach–Bliley Act, commercial banks, investment banks, securities firms, and insurance companies were allowed to consolidate.
 
3
We collect the data from Hugh Hoikwang Kim’s personal website and extend the ratio to 2020. Please refer to https://​sites.​google.​com/​site/​hughhkimswebsite​/​home.
 
4
We also investigate the validation of our measures for bank liquidity management. We found that there were 126,471 observations for positive differences between the real liquidity ratio and predicted value, while there were 112,808 observations for negative differences. The distribution appears to be fairly even for both large and small banks, indicating that computing the difference between real liquidity ratio and predicted value from the model we specified could serve as a good proxy for bank liquidity management.
 
5
A weighted average of the potential to securitize loans of a given type, as used in Loutskina (2011), is calculated as:
$${\text{Securitization}} = \mathop \sum \limits_{{j = 1}}^{6} \left( {\frac{{{\text{economy\;wide\;securitzed\;loans\;of\;type}}~j{\text{~at~time}}~t}}{{{\text{economy\;wide\;total\;loan\;outstanding\;of\;type}}j~{\text{at\;time}}~t}}} \right) \times {\text{share\;of\;type}}j~{\text{loans\;in\;bank}}i~{\text{portfolio\;at\;time~}}t~$$
 
7
To save space, we do not report the results in full. With the liquidity ratio (LIQ) as an example, the mean (median) LIQ is 0.109 (0.108) for large banks and 0.124 (0.144) for small banks. The mean (median) difference of the actual liquidity ratio and expected liquidity ratio for large banks is -0.00032 (0.0001), which is smaller than the mean (median) difference of 0.00091 (0.0002) for small banks. The other measures of liquidity show a similar pattern.
 
8
Drawing from various macroeconomic indicators, the NBER defines economic cycles based on whether the economy is expanding or contracting at a given point in time. Many studies use NBER data to identify the stage of business cycle, as seen in examples such as McKay and Reis (2008), Jenkins, Kane, and Velury (2009), and Cardarelli, Elekdag, and Lall (2011).
 
9
We also estimate the regressions using a dummy variable for downturns and repeat the tests as in Tables 7, 8, 9. The empirical tests yield similar results to those documented in Tables 7, 8, 9. To save space, the results are reported in the Internet appendix.
 
10
To save the space, we ignore the coefficients of control variables and report the coefficients of key research variables.
 
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Metadata
Title
Bank performance and liquidity management
Authors
I-Ju Chen
Hsiangping Tsai
Yan-Shing Chen
Wei Chih Lin
Ting-Yu Li
Publication date
22-09-2024
Publisher
Springer US
Published in
Review of Quantitative Finance and Accounting
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI
https://doi.org/10.1007/s11156-024-01342-9

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