Liquidity creation in dual banking systems: Do insolvency reforms matter?

Although several aspects of liquidity creation have been addressed in the literature, one area that appears to have been largely bypassed is the impact of insolvency reforms. To address this issue, we utilise bank-level data for countries with dual banking systems from 2010 to 2020 and assess its impact. In this regard, we exploit the staggered nature of insolvency reforms across countries and use a difference-in-differences specification to assess their impact. The findings reveal that insolvency reforms reduce banks' liquidity creation by an average of 2.8 per cent, primarily on the asset side. This impact differs between conventional and Islamic banks, as well as in terms of asset and liability side drivers. We view this as an early exercise for countries with dual banking systems to assess the association between insolvency reforms and liquidity creation.