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Trust towards banks plays a central role in theoretical literature. Diamond and Dybvig (1983) argue that in a trustworthy environment banks can easily collect deposit foster banking activity and asset transformation. Diamond and Rajan (2001) posit that a high trust environment discourages banks from creating liquidity. To address these conflicting views, the current study measures liquidity creation using Berger and Bouwman's (2009) methodology, then assesses the level of trust in the environment with four proxies and two additional instruments deployed in previous research. The results confirm a positive effect of trust in banks on liquidity creation, especially for small or state-chartered banks and during economic downturns. The results are robust to time effects and potential endogeneity concerns.

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