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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.

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 Emerging Economies (BOFIT).
    • Handle: RePEc:zbw:bofitp:bdp2013_002
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    More about this item

    Keywords

    liquidity creation; bank failures;

    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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