Bank regulatory capital and liquidity: Evidence from US and European publicly traded banks

Abstract

The theory of financial intermediation highlights various channels through which capital and liquidity are interrelated. Using a simultaneous equations framework, we investigate the relationship between bank regulatory capital and bank liquidity measured from on-balance sheet positions for European and U.S. publicly traded commercial banks. Previous research studying the determinants of bank capital buffer has neglected the role of liquidity. On the whole, we find that banks decrease their regulatory capital ratios when they face higher illiquidity as defined in the Basel III accords or when they create more liquidity as measured by Berger and Bouwman (2009). However, considering other measures of illiquidity that focus more closely on core deposits in the United States, our results show that small banks strengthen their solvency standards when they are exposed to higher illiquidity. Our empirical investigation supports the need to implement minimum liquidity ratios concomitant to capital ratios, as stressed by the Basel Committee; however, our findings also shed light on the need to further clarify how to define and measure illiquidity and also on how to regulate large banking institutions, which behave differently than smaller ones.

Liquidity Determinants of the Selected Banking Sectors and their Size Groups

“…The value of equity has proven signifi cant in the creation of liquidity only for the group of large banks with a negative infl uence. This negative relation to the creation of liquidity is in accordance with the fi ndings of other studies (see Berger and Bouwman, 2009;Distinguin, Roulet and Tarazi, 2013;Lei and Song, 2013 etc.). In the remaining two groups, equity was signifi cant only in the case of outfl ow (Tab.…”

“…These two concepts have been subjected to many studies. Distinguin, Roulet and Tarazi (2013) explored the relationship of these variables on US and European banks and demonstrated a negative relationship. A negative relationship is also demonstrated by Lei and Song (2013), who explore the Chinese banking market.…”

Non-performing loans (NPLs), liquidity creation, and moral hazard: Case of Chinese banks

“…They used multivariate dynamic panel regression framework and found that macroeconomic variables particularly the monetary policy indicators had a strong negative effect on liquidity creation, and bank specific variables like bank financial performance and size did not affect liquidity creation. Distinguin et al (2013) investigated the relationship between bank regulatory capital and liquidity measured from on-balance-sheet activities. They used the data of US and European publically traded commercial banks spanning 2000 to 2006.…”

The Effects of Bank Regulation on the Relationship Between Capital and Risk

“…Recent studies confirm that banks might hold liquidity as insurance against shocks and use it as a buffer, limiting the need for additional capital (Jokipii and Milne, 2011), while other banks (such as small banks) might increase capital to compensate for a lack of liquidity (Distinguin et al, 2013).…”