What Are The Channels Through Which Bank Liquidity Creation Affects GDP? Evidence From an Emerging Country

Gross domestic product (GDP) depends on myriad factor and financial intermediaries especially banks play a very important role in economic growth and development of a country. They not only lend loans rather also generate liquidity-which is very important for the smooth functioning of an economy. Therefore, this study explores the channels through which bank liquidity creation affects GDP. It uses the data from listed and unlisted Chinese banks ranging from the year 2006 to 2017. The results of the analysis reveal that the liquidity creation by Chinese banks significantly negatively affects economic output. The magnitude of the impact of small-bank liquidity creation is greater than the large banks. Variation in the GDP is explained by current and previous year's liquidity creation. Cat-fat measure of liquidity creation affects GDP directly as well as through consumption, investment, government expenditure, and net exports channels; however, cat-nonfat measure affects economic output directly and through all aforementioned channels except net exports. Overall, the findings support the hypothesis that liquidity creation affects the economy directly as well as through different channels.