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Bank Capital and Liquidity Creation : Granger Causality Evidence

Author

Listed:
  • Roman Horváth

    (Charles University, Prague and IOS, Regensburg)

  • Jakub Seidler
  • Laurent Weill

Abstract

This paper examines the relationship between capital and liquidity creation. This issue is of interest to determine the potential impact of tighter capital requirements such as those involved in Basel III reforms on liquidity creation. We perform Granger-causality tests in a dynamic GMM panel estimator framework on an exhaustive dataset of Czech banks from 2000 to 2010. We observe a strong expansion of liquidity creation during the full period, which was slowed by the financial crisis, and was mainly driven by large banks. We show that capital is found to negatively Granger-cause liquidity creation but also observe that liquidity creation Granger-causes capital reduction. These findings support the view that Basel III reforms can reduce liquidity creation, but also that greater liquidity creation can have a detrimental impact by reducing bank solvency. We thus show that there is a trade-off between the benefits of financial stability induced by stronger capital requirements and those of increased liquidity creation.

Suggested Citation

  • Roman Horváth & Jakub Seidler & Laurent Weill, 2012. "Bank Capital and Liquidity Creation : Granger Causality Evidence," Working Papers 318, Leibniz Institut für Ost- und Südosteuropaforschung (Institute for East and Southeast European Studies).
    • Handle: RePEc:ost:wpaper:318
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    bank capital; liquidity creation;

    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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