The Role of Bank Competition in influencing Bank Liquidity Creation: Evidence from China

Evidence from China

Abstract

Does increased competition among banks improve or deteriorates the liquidity creation by banks? This paper studies the impact of bank competition on banks liquidity creation. Understudy phenomena are of great interest because of the far-reaching implications on liquidity creation from pro-competitive or financial liberalization policies adopted by countries. Thus, present study will contribute to both bank competition and determinants of banks liquidity creation. To study said phenomena we used dynamic GMM panel estimations on Chinese banking dataset from 2006 to 2017. This study finds that competition (measured by Lerner index) reduces the bank's liquidity creation. We explain this finding in terms of the impact of increased bank competition on the financial fragility of banks, which leads banks to reduce their lending and deposit activities. The evidence suggests that banking industry is different from others and pro-competitive policies in the banking industry can reduce liquidity provision by banks.