The paper investigates the impact of solvency and liquidity regulation as well as market shocks on banks’ balance sheet structure. It contributes in particular to the debate on the use of liquidity buffers by banks, as initiated by Goodhart’s (2008), “last taxi” argument. The volatility of long-term markets observed during the Covid-19 pandemic shows that periods of sharp increase in risk aversion still result in liquidity strains for banks. The latter react differently depending on the diversity of their funding sources and their risk profile. Indeed, during a crisis, due to interactions between funding and market liquidity, as well as regulatory constraints, one may wonder whether banks may increase or decrease liquidity. According to a simple portfolio allocation model banks’ liquidity increases when the regulatory constraint is binding, as banks hoard extra liquidity, while they do not if the regulatory constraint is not binding. We show that in times of crisis, measured by large deviations of a financial variable capturing international markets’ risk aversion, French banks actually decreased the liquidity coefficient, with our results mostly driven by less liquid banks. However, while we do find that the solvency ratio has a weakly significant effect on the liquidity coefficient, we were not able to establish a firm causal relationship between the two variables on the basis of Granger causality tests.

In order to assess the effect of EMU on market conditions for banks based in countries which adopt the Single Currency, we use the H indicator suggested by Panzar and Rosse (Panzar, J.C., Rosse, J.N., 1987. Journal of Industrial Economics 35, 443–456). Our contribution is to assess results separately for large and small banks, and for interest income and total income as a dependent variable. From a panel of banks over the period 1992–1996, we provide evidence that the behavior of large banks was not fully competitive as compared to the US. Regarding small banks, the level of competition appears to be even lower, especially in France and Germany.

The paper investigates, from the welfare and growth point of view, the determination of the optimal capacity of the banking system. For that purpose, we consider an overlapping generation model with endogenous growth. There is horizontal differentiation and imperfect competition in the banking sector. Macro-economic shocks affect the return on capital and, together with the expectations of depositors, condition the stability of the banking sector. We specify to what extent deposit insurance may reduce instability and increase the number of deposits, welfare and growth. We also characterise the conditions under which excess banking capacities may appear and how their reduction may improve welfare.