Bank capital requirements reduce the probability of bank failure and help mitigate taxpayers’ sharing in the losses that result from bank failures. Under Basel III, direct capital requirements are supplemented with liquidity requirements. Our results suggest that liquidity provisions of banks are connected to bank capital and that changes in liquidity indirectly affect the capital structure of financial institutions. Liquidity appears to be another instrument for adjusting bank capital structure beyond just capital requirements. Consistent with Diamond and Rajan (2005), we find that liquidity and capital should be considered jointly for promoting financial stability

We analyze the impact of a requirement similar to the Basel III Liquidity Coverage Ratio on the bank intermediation applying Regression Discontinuity Designs. Using a unique dataset on Dutch banks, we show that a liquidity requirement causes long-term borrowing and lending rates as well as demand for long-term interbank loans to increase. Lower levels of aggregate liquidity increase the estimated effects. Short-term borrowing and lending rates only rise during periods of lower market-wide liquidity. Further, banks do not seem able to pass on the increased funding costs in the interbank market to their private sector clients. Rather, a liquidity requirement seems to decrease banks’ interest margins

We analyze the role of loan maturity and collateral eligibility in the transmission of central bank liquidity provisions to banks following a wholesale funding dry-up. We analyze the transmission of the three-year LTRO, which substantially extended the ECB liquidity maturity, in Italy, where banks benefited from a government guarantee program that effectively relaxed the ECB collateral requirements. Combining the national credit register with banks securities holdings, we find that (i) the maturity extension supported banks’ credit supply and (ii) banks used most liquidity to buy domestic government bonds and substitute missing wholesale funding, two possibly unstated goals of the intervention

In an economy where banks take numeraire goods, so called money, as deposits, money allows depositors suffering preference shocks to withdraw from banks prematurely without liquidation of real investment. If real liquidity, defined as the real value of the monetary base, is low, the amount of payment liquidity, constrained by the velocity of money, limits the short-term price level of investment goods before banks can settle their long-term loan contracts. This leads to an attractive nominal long-term investment return and over-investment. Allowing for inside money, that is, bank deposits, to be used for payment can improve social welfare but cannot fully resolve the liquidity shortage problem as the short-term interest rate offered by banks is constrained by the threat of bank runs. In the presence of systemic liquidity shocks, the price-adjustment mechanism cannot take full effects with insufficient payment liquidity, which can lead to non-zero profits for banks. Exchanging investment goods for numeraire goods through international trade can improve social welfare

Banks face a ‘behavioralization’ of their balance sheets since deposit funding increasingly consists of non-maturing deposits with uncertain cash flows exposing them to asset liability (ALM) risk. Thus, this study examines the behavior of banks’ retail customers regarding non-maturing deposits. Our unique sample comprises the contract and cash flow data for 2.2 million individual contracts from 1991 to 2010. We find that contractual rewards, i.e., qualified interest payments, and government subsidies, effectively stabilize saving behavior and thus bank funding. The probability of an early deposit withdrawal decreases by approximately 40%, and cash flow volatility drops by about 25%. Our findings provide important insights for banks using pricing incentives to steer desired saving patterns for their non-maturing deposit portfolios. Finally, these results are informative regarding the bank liquidity regulations (Basel III) concerning the stability of deposits and the minimum requirements for risk management (European Commission DIRECTIVE 2006/48/EC

We examine the role of bank capital in moderating the relationship between bank liquidity creation and the failure risk in U.S. banks over the period of 2003–2014. We find that, conditional on bank capital, bank liquidity creation is related to bank failure risk negatively. The negative relationship is moderated positively (i.e., strengthened) by (changes in) bank capital. This finding is consistent with the view that banks may strengthen their solvency through increased capital in response to the illiquidity risk associated with liquidity creation; and higher capital enhances the ability of banks to create liquidity. The result is robust to different estimation methods, and alternative measures of liquidity creation, bank failure risk, and bank capital. Further analysis shows that the significant and negative effect is more prominent for small banks, and the impact of bank capital was more pronounced during the recent financial crisis of 2007–2009

In this paper, we look at how the pre-crisis health of banks is related to the probability of receiving and repaying TARP capital. We find that financial performance characteristics that are related to the probability of receiving TARP funds differ for the healthiest (“over-achiever”) versus the least healthy (“under-achiever”) banks. We find that TARP under-achievers have some, but not consistent, weaknesses in income production. These banks also are experiencing liquidity issues as customers, shut out of public debt markets, get bank loans through drawdowns of loan commitments. Unlike TARP under-achievers, TARP over-achievers’ loans are performing well. Yet, liquidity issues (from low levels of liquid assets and core deposits and drawdowns of loan commitments) hurt the abilities of these banks to continue their lending. Differences between under-achiever and over-achiever banks are also found for repayment and deadbeat TARP banks

This study analyzes the impact of commercial bank affiliation on mutual funds' timing ability. In contrast to the findings for developed markets, affiliated funds outperform unaffiliated funds in China. Here, we explain affiliated funds' outperformance using 3,351 Chinese equity and hybrid mutual funds between 2008 and 2019 to demonstrate that affiliated funds are better timed than unaffiliated funds. One underlying mechanism is that affiliated funds benefit from information advantages due to the unique position of commercial banks in China's economy. Further findings reveal that better timing ability subsequently benefits commercial banking groups, indicating that commercial banks and affiliated funds share a mutual incentive compatibility relationship. A quasi-natural experiment of variations in bank affiliation verifies a causal interpretation of these findings, and our results continue to hold across a set of robustness tests

We develop a growth model with banks and markets to reconcile the observed decreasing trend in the relative liquidity of many financial systems around the world with the increasing household participation in direct market trades. At low levels of economic development, the presence of fixed entry costs prevents the agents from accessing the market, and pushes them towards the banks, which provide high relative liquidity. We characterize the threshold after which the agents are rich enough to access the market, where the relative liquidity is lower, and show that the relative liquidity of the whole financial system (banks and markets) drops because of the increasing market participation. We provide some evidence consistent with this theoretical prediction: a one-unit increase in an index of securities market liberalization leads to a drop in the relative liquidity of between 17 and 27 per cent

Using U.S. banking data between 1993 and 2014, this paper investigates the relationship between CEO optimism and bank liquidity creation. It finds that banks with optimistic CEOs create more liquidity over the entire sample period. In addition, the positive effect of CEO optimism on liquidity creation became stronger during the subprime crisis of 2007‒2009, and this stronger effect was mainly driven by banks with high capital ratios and large banks. These results imply that CEO optimism is likely to encourage banks to create liquidity, especially during banking crises. The results presented in this paper hold when subjected to various robustness checks