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Does excessive liquidity creation trigger bank failures?

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  • Fungáčová, Zuzana
  • Turk-Ariss, Rima
  • Weill, Laurent

Abstract

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

Suggested Citation

  • Fungáčová, Zuzana & Turk-Ariss, Rima & Weill, Laurent, 2013. "Does excessive liquidity creation trigger bank failures?," BOFIT Discussion Papers 2/2013, Bank of Finland, Institute for Economies in Transition.
  • Handle: RePEc:bof:bofitp:2013_002
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    References listed on IDEAS

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    1. repec:eee:jbfina:v:83:y:2017:i:c:p:36-56 is not listed on IDEAS
    2. Kundid Novokmet Ana & Marinović Antonia, 2016. "Solvency and Liquidity Level Trade-off: Does it Exist in Croatian Banking Sector?," Scientific Annals of Economics and Business, De Gruyter Open, vol. 63(3), pages 429-440, November.

    More about this item

    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

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