Estimation of liquidity created by banks in India

Sinha, Pankaj and Grover, Naina (2019): Estimation of liquidity created by banks in India.

Abstract

Risk transformation and liquidity creation are the two key functions of a bank. Liquidity Creation plays a very important role in the economy, but there is no comprehensive measure of liquidity creation that exists in our country. This study estimates the notional value of liquidity created by Scheduled commercial banks in India during the period 2005 to 2018. We have developed four measures of liquidity creation by Indian Banks,following Berger and Bouwman (2009). We have estimated Liquidity created by Banks in India is Rs.41524096 million in FY 17-18, which is 27.2 percent of total assets of all Scheduled Commercial Banks (excluding Regional Rural Banks),as per broad measure. We found off-balance sheet activities play a significant role in liquidity creation, 25 percent of the total liquidity creation as per broad measure is found to be determined by the off-balance sheet activities. Recently, there have been discussions to privatize the nationalized banks, but our study found that for FY17-18, nationalized banks contributed around 68.2 percent of total liquidity creation whereas private banks and foreign banks contributed 29.7 percentand 2.0 percent, respectively. Nationalized banks are performing quite well in liquidity creation. Though the total number of foreign banks has increased from 31 in 2005 to 45 in 2018, we found a declining trend in creating liquidity by the foreign banks. We have also estimated liquidity creation based on size. The study finds that large banks are contributing significantly towards the liquidity creation, which constitutes 94% of total liquidity creation as per broad measure.

• Item Type: MPRA Paper
• Language: English
• Keywords: Risk transformation, liquidity creation, Scheduled commercial banks, Off-balance sheet activities
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services > G20 - General; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation

References

Acharya, V., & Naqvi, H. (2012). The seeds of a crisis: A theory of bank liquidity and risk-taking over the business cycle. Journal of Financial Economics, 106(2), 349-366.

Acharya, V. V., Shin, H. S., &Yorulmazer, T. (2013). A theory of arbitrage capital. The Review of Corporate Finance Studies, 2(1), 62-97.

Berger, A. N., &Bouwman, C. H. (2009). Bank liquidity creation. The review of financial studies, 22(9), 3779-3837.

Berger, A. N., Boubakri, N., Guedhami, O., & Li, X. Liquidity Creation and Financial Stability Implications of Islamic Banking: Evidence from a Multinational Study.

Berger, A. N., &Bouwman, C. H. (2017). Bank liquidity creation, monetary policy, and financial crises. Journal of Financial Stability, 30, 139-155.

Berger, A. N., &Sedunov, J. (2017). Bank liquidity creation and real economic output. Journal of Banking & Finance, 81, 1-19.

Deep, A., & Schaefer, G. K. (2004). Are banks liquidity transformers?

Diamond, D. W., &Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of political economy, 91(3), 401-419.

Diamond, D.W. and Rajan, R.G. (2000), “A theory of bank capital”, Journal of Finance, Vol. 55 No. 6, pp. 2431-2465.

Fungáčová, Z., & Weill, L. (2012). Bank liquidity creation in Russia. Eurasian Geography and Economics, 53(2), 285-299.

Greenbaum, S., &Thakor, A. (2007). Contemporary Financial Intermediation, Academic Press.

Holmström, B., &Tirole, J. (1998). Private and public supply of liquidity. Journal of Political Economy, 106(1), 1-40.

Kashyap, A. K., Rajan, R., & Stein, J. C. (2002). Banks as liquidity providers: An explanation for the coexistence of lending and deposit‐taking. The Journal of Finance, 57(1), 33-73.

Sabahat, S. (2017). Estimating Liquidity Created by Banks in Pakistan (No. 86). State Bank of Pakistan, Research Department

Steffen, S., Hackethal, A., & Tyrell, M. (2010). Determinants of bank liquidity creation.