Bank Liquidity Creation and Regulatory Capital in Asia Pacific
According to the modern theory of financial intermediation, one of the two central roles played by banks is liquidity creation. Bryant (1980) and Diamond and Dybvig (1983) suggest that banks create liquidity on the balance sheet by financing relatively long-term illiquid assets with relatively short-term liquid liabilities. Holmstrom and Tirole (1998) and Kashyap et al. (2002) argue that banks also create liquidity off-balance sheet by offering loan commitments and generating similar claims to liquid funds. Therefore, banks hold illiquid assets/loan commitments and provide liquidity to stimulate the rest of the economy. Such a liquidity creation function attracted significant attention recently because the global financial crisis of 2008–09 vividly demonstrated that illiquidity can dramatically affect macroeconomic stability. As an outcome, one major regulatory response has been the introduction of Basel III that introduces higher liquidity and capital standards with the goal of promoting a more resilient banking sector (BIS, 2011).
KeywordsTotal Asset Regulatory Capital Large Bank Small Bank Capital Ratio
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