The inter-relationships among liquidity creation, bank capital and credit risk: evidence from emerging Asia-Pacific economies

Purpose This study investigates the inter-relationships among liquidity creation, bank capital and credit risk in selected emerging economies between 2012 and 2016. Design/methodology/approach A three-step procedure as proposed by Berger and Bouwman (2009) is used to measure liquidity creation. Thereafter, a simultaneous equations model with the generalized method of moments (GMM) estimator is used to examine the links between liquidity creation, bank capital and credit risk. Findings The findings indicate that bank capital and credit risk affect each other positively after controlling for liquidity creation. Also, the findings show a negative impact of credit risk on liquidity creation while our findings do not find any evidence to confirm the reverse relationship between them. Furthermore, the findings demonstrate a two-way negative relationship between liquidity creation and bank capital in these emerging economies. Finally, the results indicate a positive relationship between capital and credit risk, especially in the case of small banks in the sample. Practical implications The findings suggest that the trade-off between the benefits of financial stability induced by tightening capital requirements and those of improved liquidity creation has crucial implications for policymakers and bank regulators in making the banking system more resilient. A positive impact of capital on credit risk emphasizes that the authorities in selected emerging economies should put more attention on small banks to ensure their exposures under target control. Originality/value This is the first study that examines the dynamic interrelationships among liquidity creation, bank capital and credit risk in the Asia-Pacific region.