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The effect of liquidity creation on systemic risk: evidence from European banking sector

Author

Listed:
  • Waël Louhichi

    (ESSCA School of Management)

  • Nadia Saghi

    (University of Rennes 1)

  • Zainab Srour

    (University of Rennes 1
    Lebanese University)

  • Jean-Laurent Viviani

    (University of Rennes 1)

Abstract

The goal of this paper is to examine the effect of high liquidity creation on systemic risk. We use a hand-collected dataset on 94 banks from 16 Western European countries over the 2004–2020 period, including the crisis (2008–2009) period and sound periods (2004–2007 and 2010–2020). We assess banks’ systemic risk using two different proxies: banks’ systemic risk exposure, measured by the marginal expected shortfall (MES), and banks’ systemic risk contribution, measured by the delta conditional value at risk (ΔCoVaR). Based on panel regressions, our results mainly show that, during calm periods, high liquidity creation is associated with high systemic risk exposure. Moreover, we show that the effect of liquidity creation on banks’ systemic risk exposure is stronger during turmoil periods. Interestingly, our results show that banks’ liquidity creation increases the systemic contribution only during the financial crisis of 2008–2009. Our findings contribute to the literature and the regulatory debate by suggesting that regulators should pay more attention to high liquidity-creating banks as they may cause aggregate financial fragility.

Suggested Citation

  • Waël Louhichi & Nadia Saghi & Zainab Srour & Jean-Laurent Viviani, 2024. "The effect of liquidity creation on systemic risk: evidence from European banking sector," Annals of Operations Research, Springer, vol. 334(1), pages 357-389, March.
    • Handle: RePEc:spr:annopr:v:334:y:2024:i:1:d:10.1007_s10479-022-04836-8
    DOI: 10.1007/s10479-022-04836-8
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    More about this item

    Keywords

    Systemic risk; Liquidity creation; Fire sale; MES; ΔCoVaR;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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