Net stable funding ratio and profit efficiency of commercial banks in the US

Abstract

The net stable funding ratio (NSFR) is introduced under Basel III to promote financial stability.Under this new regulation, individual financial institutions are required to maintain a sustainable funding structure; hence this new universal requirement is expected to affect bank operation. In this paper, we provide one of the first empirical examinations of the non-linear relationship between NSFR and profit (in)efficiency for commercial banks using two data sets from Bankscope (for years from 2000 to 2015) and Federal Financial Institutions Examination Council call reports (2000-2013 period). Our results suggest that modest intensification in liquidity helps to reduce bank profit inefficiency (i.e. increase efficiency) but too much liquidity enlargement could increase the inefficiency. This result is consistent with a trade-off hypothesis on the non-linear relationship between liquidity and bank performance.

The Impact of Net Stable Funding Ratio on Bank Performance and Risk Around the World

“…This means that the impact of liquidity on bank performance becomes weaker (less negative) once we consider non-linearity. Our results are consistent with Le et al (2020), who document that the relationship between liquidity and bank performance is nonlinear. In other words, our findings suggest that excessive liquidity has a minimal negative impact on bank performance.…”

“…Overall, our findings are consistent with prior studies, which document that an increase in liquidity leads to lower bank performance (see for instance, Le et al, 2020;Acharya & Naqvi, 2012;Grundke & Kühn, 2019;Naceur et al, 2018); in other words, this implies that more liquid banks are associated with lower profitability. When banks maintain their liquidity (NSFR), they reduce loans from unstable funds, thereby lowering lending, and, consequently, lowering profit.…”

“…When banks maintain their liquidity (NSFR), they reduce loans from unstable funds, thereby lowering lending, and, consequently, lowering profit. Higher liquidity decreases the lending rate (Acharya & Naqvi, 2012), lending growth (Naceur et al, 2018), and bank inefficiency (Le et al, 2020). We conclude that our findings are consistent with the trade-off hypothesis, which states that too much liquidity may have a detrimental effect on bank performance (see King, 2013).…”

“…Our study is distinctive from previous works and offers some new insights. Firstly, we extend previous studies by accommodating non-linear relationships, as earlier discussed (Le et al, 2020;Ly et al, 2017). Secondly, since we do not know the NSFR's ultimate impact yet, our study provides more recent empirical evidence by including the post-implementation period 6 .…”

“…Prior studies are insufficient for the following reasons. Firstly, most of the previous studies have not considered non-linear relationships (Le et al, 2020) between liquidity and performance or risk (Dietrich et al, 2014;Grundke & Kühn, 2019). Secondly, to best our knowledge, most recent studies 3 use datasets without considering the post-implementation period of NSFR (Basel III) 4 .…”