Cyclicality of liquidity creation: Nonlinear evidence from US bank holding companies

Document Type

Article

Source of Publication

Journal of Financial Research

Publication Date

1-1-2023

Abstract

Using a panel smooth transition regression framework on a new proxy of the business cycle (BC) index and quarterly data of US bank holding companies from 1993Q1 to 2020Q1, our results provide empirical support for the theory that the BC has a nonlinear effect on liquidity creation. We find a positive and highly significant nonlinear effect of the BC on liquidity creation, which not only supports the pro-cyclicality of liquidity creation but also improves the liquidity creation estimation compared to previous studies. The results are robust to different proxies of the BC and model specifications. We also document that US bank holding companies create liquidity more during the expansion phase (normal times) than during the recession phase (crisis times) of the BC, suggesting an asymmetrical effect of BC changes on liquidity creation. Our findings have important implications for financial market participants by suggesting that banks should keep alternative sources of funding on hand during the BC recession phase. Insights from our study also provide policy implications for central banks and prudent supervisors to consider when incentivizing banks, for instance, by lowering regulatory requirements, adjusting the policy rate, or implementing any other quantitative easing policy during the BC recession phase to keep the financial system efficient.

ISSN

0270-2592

Publisher

Wiley

Disciplines

Business

Keywords

Liquidity creation, Business cycle (BC), Bank holding companies, Pro-cyclicality, Financial market participants

Scopus ID

85171274964

Indexed in Scopus

yes

Open Access

yes

Open Access Type

Bronze: This publication is openly available on the publisher’s website but without an open license

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