Does excessive liquidity creation trigger bank failures?
Fungáčová, Zuzana; Turk-Ariss, Rima; Weill, Laurent (23.01.2013)
JulkaisusarjaBOFIT Discussion Papers
JulkaisijaBank of Finland
Julkaisun pysyvä osoite onhttps://urn.fi/URN:NBN:fi:bof-201408071988
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.
Published in Journal of Financial Stability 2021 ; 57 ; December https://doi.org/10.1016/j.jfs.2021.100937 and IMF Working Paper No. 15/103 (May 06, 2015) as High Liquidity Creation and Bank Failures.