Does Excessive Liquidity Creation Trigger Bank Failures?

Does Excessive Liquidity Creation Trigger Bank Failures?
 
Zuzana Fungacova
Bank of Finland Institute for Economies in Transition (BOFIT), Helsinki, Finland
 
Rima Turk Ariss
Lebanese American University, Beirut, Lebanon
 
Laurent Weill
EM Strasbourg Business School, University of Strasbourg, Strasbourg, France


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.

JEL Classification: G21; G28; P30
Keywords: Liquidity Creation, Bank Failures, Russia