Basel III Liquidity Creation and Bank Capital
Liquidity creation refers to a banks’ function of extending illiquid loans to borrowers while providing depositors with the opportunity to withdraw funds upon demand at par value.1–4 In this chapter, we first determine how to analyze the connections between liquidity creation and bank capital. By using a Granger causality approach, we investigate the causal relationship between bank capital and liquidity creation5 (broad and narrow measure) and its directionality in large, medium, and small banks.6 Second, we are interested in the risks that liquidity creation generates for the bank. In a Basel III context, various aspects of such risk are taken into account by incorporating earnings volatility, ...
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