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Does excessive liquidity creation trigger bank failures?

Listed author(s):
  • Fungáčová, Zuzana
  • Turk-Ariss, Rima
  • Weill, Laurent

This paper introduces the "Excessive Liquidity Creation Hypothesis," whereby a rise in a bank's core liquidity creation activity increases its probability of failure. Russia experienced many bank failures over the past decade, making it an ideal natural field experiment for testing this hypothesis. Using Berger and Bouwman's (2009) liquidity creation measures, we find that excessive liquidity creation significantly increased the probability of bank failure during our observation period (2000?2007). This finding survives multiple robustness checks. Our results further suggest that regulatory authorities can mitigate systemic distress and reduce the costs to society from bank failures through early identification and enhanced monitoring of excessive liquidity creators. JEL Classification: G21; G28 Keywords: liquidity creation, bank failures

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Paper provided by Bank of Finland, Institute for Economies in Transition in its series BOFIT Discussion Papers with number 2/2013.

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Date of creation: 23 Jan 2013
Handle: RePEc:bof:bofitp:2013_002
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