BOFIT Discussion Papers, Institute for Economies in Transition, Bank of Finland
Does excessive liquidity creation trigger bank failures?
(), Rima Turk Ariss
() and Laurent Weill
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.
Keywords: liquidity creation; bank failures; (follow links to similar papers)
JEL-Codes: G21; G28; (follow links to similar papers)
35 pages, January 21, 2013
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