Knowledge that Transforms

Although the modern theory of financial intermediation portrays liquidity creation as an essential role of banks, comprehensive measures of bank liquidity creation do not exist. We construct four measures and apply them to data on virtually all U.S. banks from 1993 to 2003. We find that bank liquidity creation increased every year and exceeded $2.8 trillion in 2003. Large banks, multibank holding company members, retail banks, and recently merged banks created the most liquidity. Bank liquidity creation is positively correlated with bank value. Testing recent theories of the relationship between capital and liquidity creation, we find that the relationship is positive for large banks and negative for small banks.