Fungáčová, Turk Ariss and Weill: Does Excessive Liquidity Creation Trigger Bank Failures?

Thuesday
12.6.2012
at 10.30

Zuzana Fungáčová (BOFIT), Rima Turk Ariss (Lebanese American University) and Laurent Weill (University of Strasbourg): Does Excessive Liquidity Creation Trigger Bank Failures?

Abstract
This paper introduces a new hypothesis to explain bank failures. According to this “Excessive Liquidity Creation Hypothesis” excessive liquidity creation contributes to the increasing probability of bank failures. We test this issue by employing the data on the Russian banking industry that saw a large number of bank failures during the 2000s. We measure bank liquidity creation following Berger and Bouwman (2009)’s methodology. We show that excessive liquidity creation increases the probability of bank failures. This finding survives several robustness checks. The implication is that regulatory authorities might use liquidity creation measures to identify potential financial institutions in distress.