This study highlights how regulators and policymakers over-emphasize the risk-minimizing role of capital and overlook the trade-off between financial stability and output.
Authors
Pankaj Sinha, Professor, The University of Delhi Faculty of Management Studies, Delhi School of Economics, University Enclave, Delhi, India.
Naina Grover, Lecturer, Jindal Global Business School, O.P. Jindal Global University, Sonipat, Haryana, India.
Summary
This study explores the interrelationship between liquidity creation and capital for scheduled commercial banks operating in India during 2005-2019. Liquidity creation construct is developed following the approach of Berger and Bouwman (2009).
Using a simultaneous equation model with GMM estimator, a negative bi-directional relationship is observed between the two, which suggest higher capital will decrease liquidity creation and vice versa.
This relationship holds for different ownership structures as well. This study highlights how regulators and policymakers over-emphasize the risk-minimizing role of capital and overlook the trade-off between financial stability and output.
It is also observed that when banks face illiquidity, they prefer deposits over capital because they are considered to be stable and better accessible.
Published in: Finance India
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