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Bank Capital, Liquidity Creation and Deposit Insurance

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Abstract

This paper examines how the introduction of deposit insurance influences the relationship between bank capital and liquidity creation. As discussed by Berger and Bouwman (Rev Financ Stud 22:3779–3837, 2009), there are two competing hypotheses on this relationship which can be influenced by the presence of deposit insurance. The introduction of a deposit insurance scheme in an emerging market, Russia, provides a natural experiment to empirically investigate this issue. We use the difference-in-difference approach on a large dataset of all Russian banks. Our findings suggest that the introduction of the deposit insurance scheme has different effects on the relationship between capital and bank liquidity creation across different types of banks. It is those banks characterized by relatively high household deposit ratios that are most affected by the introduction of deposit insurance program. For these banks, deposit insurance reduces the impact of capital on liquidity creation. These findings have important policy implications as they suggest that deposit insurance and capital requirements should not be considered separately by bank regulators.

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Notes

  1. According to standard liquidity creation theory, a bank creates liquidity by transforming illiquid assets into liquid liabilities. Diamond and Rajan (2000) however point out that liquidity is also created by simply changing banks’ funding mix on their liability side. Berger and Bouwman (2009) consider changes in the mixes on both sides of banks’ balance sheets and also off-balance sheet activities.

  2. Distinguin et al. (2013) and Horvath et al. (2014) also provide analyses of the relation between capital and liquidity creation on US and European banks.

  3. Federal Law Nr. 177-FZ of December 23, 2003.

  4. Following on-site bank examination, applications of 191 banks were rejected by regulators and the licenses of another 24 banks were revoked (Chernykh and Cole 2011).

  5. According to Camara and Montes-Negret (2006), 98.5 % of deposit accounts were under 100,000 rubles and thus fully insured at the end of 2005. The coverage has been gradually increased to 190,000 rubles in August 2006, 400,000 rubles in March 2007 and 700,000 rubles in October 2008.

  6. Mondschean and Opiela (1999) provide an investigation of the impact of changes in the deposit insurance system in another transition country, Poland.

  7. See also Benston (1992) for the purpose of capital for banks covered by deposit insurance scheme.

  8. For a more detailed description of the dataset, see Karas and Schoors (2005).

  9. Russian regulations require withdrawal of a bank’s license if its capital ratio falls below 2 %.

  10. See also the book from Berger and Bouwman (2015) for extensive information on bank liquidity creation.

  11. We do not consider off-balance sheet activities; they were not significant for most of the investigated period.

  12. Household income is defined as regional household income per capita and small enterprise business variable is calculated as number of small and medium-sized enterprises (SMEs) in a given region multiplied by the average number of employees SMEs have in that region. Both household income growth and small business growth variables are calculated as weighted averages of regions in which a bank has its operations. We use weights based on the distribution of branch offices in regions.

  13. As we discuss before, the implementation of the DIS was not completed until the end of year 2005.

  14. One can argue that even if state-owned banks were not directly influenced by the introduction of the deposit insurance, they could have been indirectly influenced through the fact that the deposit insurance has removed a competitive advantage relative to private banks, which could have influenced their cost of capital relative to these other banks. However, bank competition in Russia during the period 2001 to 2006 increased for both state-owned and private banks (Fungacova et al. 2010). Thus, as our investigation is based on the comparison of private banks and state-owned banks, and as competition in both groups of banks has evolved in the same way, the evolution of competition should not have influenced liquidity creation over the period of study.

  15. Results are qualitatively similar when using earnings volatility to measure risk.

  16. Based on Stock and Yogo (2005), Stock-Yogo weak ID test critical values for Cragg-Donald F statistic and i.i.d. errors are: 10 % maximal IV size: 19.93; 15 % maximal IV size: 11.59; 20 % maximal IV size: 8.75; 25 % maximal IV size: 7.25.

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Authors and Affiliations

  1. Bank of Finland—Institute for Economies in Transition (BOFIT), Snellmaninaukio, PO Box 160, 00101, Helsinki, Finland

    Zuzana Fungáčová

  2. EM Strasbourg Business School, University of Strasbourg and Bank of Finland, 47 avenue de la Forêt Noire, 67082, Strasbourg Cedex, France

    Laurent Weill

  3. College of Business and Administration, University of Colorado at Colorado Springs, 1420 Austin Bluff Pkwy, Colorado Springs, CO, 80918, USA

    Mingming Zhou

  4. IES, Charles University, Prague, Czech Republic

    Zuzana Fungáčová

Authors
  1. Zuzana Fungáčová
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  2. Laurent Weill
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  3. Mingming Zhou
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Corresponding author

Correspondence to Zuzana Fungáčová.

Appendix

Appendix

1.1 Definitions of liquidity creation measures

The following are definitions of the balance sheet items in terms of their liquidity, which is the basis for calculation of the liquidity creation measures. The general functional form to calculate liquidity creation is given by Eq. (1) and the weights of different items are reported in this table in the parentheses. In constructing the category based liquidity creation measure (LC1), we classify the bank activities based on the categories. LC2 is based on the category as well as the maturity classification which is available for interbank loans and all liabilities.

LC1: CATEGORY MEASURE

 

Illiquid assets (1/2)

Semi-liquid assets (0)

Liquid assets (−1/2)

 

 Loans to firms

 Interbank loans

 Correspondent accounts with other banks

 

 Other assets

 Loans to government

 Government securities (incl. securities issued by regions and municipalities)

  

 Loans to individuals

 Investments to promissory notes

 

Liquid liabilities (1/2)

Semi-liquid liabilities (0)

Illiquid liabilities and capital (−1/2)

 

 Debt securities issued (promissory notes)

 Debt securities issued (deposit and saving certificates, bonds)

 Other liabilities

 

 Claims of non-bank sector : settlement accounts (firms, households, government)

 Claims of non-bank sector : term deposits accounts (firms, households, government)

 Capital

 

 Claims of banks

  

LC2: MATURITY MEASURE

 

Illiquid assets (1/2)

Semi-liquid assets (0)

Liquid assets (−1/2)

 

 Interbank loans (maturity more than 1 year, nonperforming interbank loans)

 Interbank loans (maturity more than a week and less than 1 year)

 Interbank loans (maturity less than a week)

 

 Loans to firms

 Loans to government

 Correspondent accounts with other banks

 

 Other assets

 Loans to individuals

 Government securities (incl. securities issued by regions and municipalities)

   

 Investments into prom. notes

 

Liquid liabilities (1/2)

Semi-liquid liabilities (0)

Illiquid liabilities and capital (−1/2)

 

 Liabilities with maturity lower than 90 days

 Liabilities (term deposits and debt securities) with maturity less than 1 year

 Liabilities (term deposits, debt securities) with maturity more than 1 year and overdue liabilities and liabilities with uncertain term to maturity

 

 Current and corresponding accounts

 

 Capital

1.2 Additional figures of liquidity creation, capital ratio, liquidity creation-to-capital sensitivity over time for control group vs treatment group

Fig. 1
figure 1

Plot of liquidity creation (LC2) over time for control group vs. treatment group

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Fig. 2
figure 2

Plot of liquidity creation (LC3) over time for control group vs. treatment group

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Fig. 3
figure 3

Plot of liquidity creation (LC1)-to-capital sensitivity over time for control group vs. treatment group, where risk proxy = NPL

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Fig. 4
figure 4

Plot of liquidity creation (LC1)-to-capital sensitivity over time for control group vs. treatment group, where risk proxy = Volatility

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Fig. 5
figure 5

Plot of liquidity creation (LC2)-to-capital sensitivity over time for control group vs. treatment group, where risk proxy = NPL

Full size image
Fig. 6
figure 6

Plot of liquidity creation (LC2)-to-capital sensitivity over time for control group vs. treatment group, where risk proxy = Volatility

Full size image

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Fungáčová, Z., Weill, L. & Zhou, M. Bank Capital, Liquidity Creation and Deposit Insurance. J Financ Serv Res 51, 97–123 (2017). https://doi.org/10.1007/s10693-016-0240-7

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  • DOI: https://doi.org/10.1007/s10693-016-0240-7

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