Bank capital and liquidity creation. An empirical study of the Scandinavian Banks

Abstract

Little is known about the impact of capital regulation on the liquidity creation capabilities of Scandinavian banks. This thesis attempts to examine the relationship between bank capital and liquidity creation based on an unbalanced panel data of 28 banks using quarterly data for the period 2009 to 2016. Based on our measure of liquidity creation, we find that banks on average have managed to consistently increase liquidity creation during the sample period. Using fixed effect regressions on two separate independent variables as proxy for bank capital, we find evidence of a positive relationship between bank capital and liquidity creation for the big Scandinavian banks. This evidence lends credence to the risk absorption hypothesis. However, we find a negative relationship between capital and liquidity creation for the small banks consistent with the financial fragility-crowding out hypothesis. Taken together our results suggest that bank size is an important characteristic in determining an average bank’s responsiveness to capital regulations.