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The Bank Liquidity Creation and Equity Capital Puzzle

Author

Listed:
  • Berger, Allen N.

    (University of South Carolina - Darla Moore School of Business)

  • Guo, Jiarui

    (University of International Business and Economics)

  • Li, Xinming

    (Nankai University)

  • Wang, Aluna

    (HEC Paris)

  • Wang, Wenting

    (University of South Carolina)

Abstract

We revisit the bank capital-liquidity creation debate using quarterly US bank data for 20 years from 2003:Q1-2022:Q4, investigating for first time how relations differ for bank outputs versus inputs and for major outputs and inputs. We find a negative overall relation between capital and liquidity creation for small banks, consistent with the Financial Fragility-Crowding Out (FFCO) Hypothesis and a positive relation for large banks, consistent with the Risk Absorption (RA) Hypothesis. Key contributions are that we find much of the explanation of the size-class difference lies in the different effects for outputs versus inputs and for major outputs and inputs.

Suggested Citation

  • Berger, Allen N. & Guo, Jiarui & Li, Xinming & Wang, Aluna & Wang, Wenting, 2025. "The Bank Liquidity Creation and Equity Capital Puzzle," HEC Research Papers Series 1582, HEC Paris.
    • Handle: RePEc:ebg:heccah:1582
    DOI: 10.2139/ssrn.5381609
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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • 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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