The purpose of this paper is to investigate the interrelationship between liquidity creation (LC) and bank capital in Vietnamese banking between 2007 and 2015.
A three-step procedure is used to measure LC. Thereafter, a simultaneous equations model with a three-stage least squares estimator is employed to examine the links between LC and bank capital.
The findings show that large banks mainly contributed a strong growth in LC in Vietnam between 2007 and 2015. The findings also indicate that off-balance sheet activities only played a small role in LC. In addition, the findings indicate a negative two-way relationship between LC and bank capital in Vietnam. The results of the robust checks reinforce the main findings.
The evidence shows that the implementation of Basel III may reduce LC and greater LC may increase banks’ insolvency. Consequently, this trade-off between the benefits of financial stability induced by tightening capital requirements and those of enhanced LC has important implications for Vietnamese authorities in strengthening the banking system.
This study is the first attempt to investigate the interrelationship between LC and bank capital in Vietnam, in which fat liquidity creation and non-fat liquidity creation are used and alternative measures of LC are also employed to provide robustness to the main findings.
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