Bank Capital and Liquidity Creation : New Evidence from a Quantile Regression Approach

The purpose of this research paper is to examine the effect of bank capital on liquidity creation. Especially, we test two competing hypotheses: the “risk absorption” hypothesis and the “financial fragility-crowding out” hypothesis that describes such association in the context of UK and French banking industry. We use data collected from Bankscope for commercial banks pertaining to the aforementioned countries. The sample period range from 2000 to 2014. Liquidity creation was measured using a novel approach proposed by Berger and Bowman (2007). This study uses the quantile regression and the instrumental variables quantile regression, along with classical Ordinary Least Squares (OLS) and Panel regression, to deal with the mixed results reported by previous papers. Using OLS and panel regression, we first find that bank capital affects negatively liquidity creation which supports risk absorption hypothesis. Second, the result from quantile regression confirms the negative association between the aforementioned variables and shows that the effect is homogenous across quantiles of liquidity creation distribution.. Our result remains unchanged when using the quantile regression with instrumental variables to address potential problem of endogineity. This paper sheds more lights on the relationship between bank capital and liquidity creation by using a novel estimation approach based on the quantile regression methododolgy