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Bank Liquidity Creation, Monetary Policy, and Financial Crises

Author

Listed:
  • Berger, Allen N.

    (University of SC and Wharton Financial Institutions Center, University of PA)

  • Bouwman, Christa H. S.

    (Case Western Reserve University and Wharton Financial Institutions Center, University of PA)

Abstract

Monetary policy efficacy depends largely on how it affects bank behavior. Recent events have cast doubt on how well monetary policy works in this regard, particularly during financial crises. In addition, issues have been raised about the role of banks in creating asset bubbles that burst and lead to crises. In this paper, we address these issues by focusing on bank liquidity creation, which is a comprehensive measure of bank output that accounts for all on- and off-balance sheet activities. Specifically, we formulate and test hypotheses that address the following questions: (1) How does monetary policy affect bank liquidity creation during normal times? (2) Does monetary policy affect bank liquidity creation differently during financial crises versus normal times? (3) Is high aggregate bank liquidity creation an indicator of an impending financial crisis? We have three main findings. First, during normal times, monetary policy affects liquidity creation, but only for small banks. Second, the effects of monetary policy are weaker for banks of all sizes during financial crises than during normal times. Third, liquidity creation tends to be high (relative to trend) prior to financial crises and has incremental explanatory power in predicting crises even after controlling for other macroeconomic factors.

Suggested Citation

  • Berger, Allen N. & Bouwman, Christa H. S., 2011. "Bank Liquidity Creation, Monetary Policy, and Financial Crises," Working Papers 11-21, University of Pennsylvania, Wharton School, Weiss Center.
    • Handle: RePEc:ecl:upafin:11-21
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    File URL: http://fic.wharton.upenn.edu/fic/papers/11/11-21.pdf
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    Citations

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    Cited by:

    1. Horvath, Roman & Seidler, Jakub & Weill, Laurent, 2016. "How bank competition influences liquidity creation," Economic Modelling, Elsevier, vol. 52(PA), pages 155-161.
    2. repec:zbw:bofitp:2013_002 is not listed on IDEAS
    3. repec:zbw:bofitp:2013_016 is not listed on IDEAS
    4. Roman Horváth & Jakub Seidler & Laurent Weill, 2014. "Bank Capital and Liquidity Creation: Granger-Causality Evidence," Journal of Financial Services Research, Springer;Western Finance Association, vol. 45(3), pages 341-361, June.
    5. Zuzana Fungacova & Ms. Rima A Turk & Laurent Weill, 2015. "High Liquidity Creation and Bank Failures: Do They Behave Differently?," IMF Working Papers 2015/103, International Monetary Fund.
    6. Horvath, Roman & Seidler, Jakub & Weill, Laurent, 2016. "How bank competition influences liquidity creation," Economic Modelling, Elsevier, vol. 52(PA), pages 155-161.
    7. Peter Spahn, 2014. "The Bank Lending Channel in a Simple Macro Model - How to Extend the Taylor Rule?," ROME Working Papers 201409, ROME Network.
    8. 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.
    9. Bhatta, Dhiraj, 2022. "Sustainable Growth Decisions and Strategies of the US Agricultural and Non-Agricultural Banks during the COVID Pandemic Period," 2022 Annual Meeting, July 31-August 2, Anaheim, California 322325, Agricultural and Applied Economics Association.

    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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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