The Role of Government on Bank Liquidity Creation - Research Paper Example

Name: Professor: Course: Date: The Role of the government on Bank Liquidity Creation Introduction This study was prompted by the financial crisis that took place in the United States of America during the years 2007 and 2008. This crisis provided a platform for the study to ascertain the factors that might be facilitating quick evaporation of liquidity and how this illiquidity situation lasted. The persistence of this crisis affected even the well established financial institutions which previously had an adequate capital base. This case made banks liquidity management to be a great challenge. The study confirms the two liquidly variables that are “cat fat” and “cat nonfat “variables. Based on the three-step procedures, assets, liability and equity, these variables can be calculated to get their classifications which are liquid, semi-liquid and illiquid. The above three categories depend entirely on the ease, cost and the time that a financial institution is likely to take to credit a customer’s account. The same procedure mentioned above can be used to classify all the off-sheet items. The next step is where the weights are assigned to the financial institution with the aim of ensuring that the activities carried out by these organizations are consistent with liquidity theory. The study establishes that the actual weights can be attached to both liquid liabilities and illiquid assets with the aim of creating liquidity in case of finance illiquid asset. The study establishes that depositors can be used in financing SMEs which are small enterprises in nature. The negative weights can be attached to illiquid liabilities, liquid assets, and equity during this economic crisis. In this case, the liquidity shall decline to be in illiquid liabilities of capital with the aim of financing liquid assets. During the last step which is the third one, the multiplication of each item results in the creation of liquidity variables. This can facilitate the calculation of the four different forms of liquidity with regards to loans or the two categories which are cat and mat. Moreover, this study aims at looking at the classification of loans with regards to the two classes mentioned above. The cat fat which has four liquidity approaches are the best liquidity indicators since their maturities are directly linked to the two categories (Berger, Allen and Gregory 650). However, not every good liquidator with regards to time, cost and ease can be used to stabilize liquidity securitization to acquire capital during the financial crisis. The study looks at the role of off-sheet activities and the general outlook of the liquidity creation process. During the study, nonfat cat approaches were used with liquidity models to ascertain the liquidity creation which entails balance sheet activities. Various scholars highlight that an average of 50% liquidity can be created following the on balance sheet activities. The research questions include: 1. Does the liquidly persistence crisis affect the financial abilities to create capital? 2. How can this financial crisis get solved? Background literature With regards to the previous studies on this liquidity crisis topic, it was established that majority of the financial institutions failed terribly in creating liquidity following the basic principles of managing the risks that were likely to come up during the times when they still had a lot of liquidity. The research was conducted by the Basel Committee whose primary concern was to supervise the financial institutions in the United States of America. This risk failure and governance of the financial system was further confirmed by the research conducted by the new bank regulation, the news headlines, and the banking research studies. In their research, they determined the predominance weaknesses in the banking governance with an aim of dealing with challenges that arise from a liquidity crisis. The Wall Street Journal of the United States of America also conducted research regarding the liquidity crisis, and it found out that improving liquidity in the financial institution's governance would have greater positive impacts on the banking system. Moreover, this financial crisis of the years 2007 and 2008 in America exposed several faults in the financial sector in this country (Cornett et al 300). Data and model The research retrieves the data from the American financial institutions regarding the financial corporate level governance with the aim of analyzing them to ascertain this liquidity crisis and its impacts on the current and future economic sectors. This study also looks at the American bank holding companies (BHCs) about their governance as between 2003 and 2009. The empirical economic data shows the scores which are available to be a total of 500 public banks holding companies to sample during the data collection. Indeed since the year 2003, the ISS, BI0 annual provided some more information on the financial institution governance systems which attributed to the CGQ matrix as seen in the model table below. This model shows that some datasets changed their composition up to the year 2009. This economic used to test the hypothesis constructs the governance approaches by using the features of liquidity that were in existence until the year 2009 (Campello et al 19500). The model creates a final sampling by putting together ISS management data and the two data sources of liquidity. The Federal Bank of Chicago and the Berger, Bowman, collected this liquidity information in a systematic manner for easy interpretation. In interpreting the aggregate bank level liquidity data from the 4307 financial institutions of America holding companies, the research joins the top regulatory holders to the free financial institutions. Moreover, the researcher joins these data together with the accounting and financial information that are FR Y-reports with the aim of evaluating the bank holding companies. The researcher leaves out the study of the remaining 989 bank holding companies due to the absence of loan outstanding, the lack of deposits, negative values of total equity and the presence of less than a financial year data. The model shows how the bank holding companies work jointly with ISS governance scores. The full dataset for the model includes 247 banking holding companies and 7721 bank quarterly indications. This economic model examines data from 3295 leading financial institutions and 1645 from the small financial institutions (Douglas and Philip 500). All banks Large Medium Small High liquidity Low liquidity Observations 7721 3295 2762 1645 1928 1916 BHCs 247 160 168 135 111 173 Cat fat (000s) mean 9,412,355 21,263,864 265,603 35,213,053 35,213,053 80,430 Std Deviation 53,170,173 79,838,426 373,991 134,551 102,079,344 2,015,066 Governance Mean 5464,249 12,183,380 600,335 211,050 20,260,305 (245,847) Std Deviation Z-score Mean 26,993,879 40,338,977 299,715 108, 664 108,664.71 50,995,048 4663,765 Std Deviation Equity Mean 17.63 20.06 17.32 13.33 18.66 17.09 Std Deviation Credit Risk Mean 8.09 8.41 7.87 5.54 8.43 7.96 Std Deviation ROA Mean 33.87 35.21 34.03 45.01 35.85 43.24 Std Deviation ROE mean 27.51 19.46 44.54 20.12 20.12 41.45 Std Deviation  s) Mean 10.84% 10.69% 10.21% 12.20% 10.97% 11.83% Std Deviation 6.15% 4.10% 5.14% 9.81% 4.93% 8.76% Credit Risk Mean 76.49% 73.04% 74.52% 86.17% 78.04% 78.42% Std Deviation ROA 40.71% 30.38% 28.95% 66.02% 37.24% 59.05% Mean 0.47% 0.49% 0.44% 0.48% 0.50% 0.44% Std Deviation ROE 0.74% 0.76% 0.74% 0.68% 0.71% 0.71% Mean 4.95% 4.68% 4.05% 6.97% 5.06% 5.53% Total Assets (000 s) Mean 20,734,744 4.68% 28.77% 90.20% 8.09% 88.47% Std Deviation 127,711,939 12.48% 28.77% 90.20% 8.09% 88.47% Total Assets (000 s) Mean 20,734,744 46,625,187 1851,856 727,435 73,448,108 3779,367 Std Deviation 127,711,939 192,403,988 941,627 455,494 246,420,796 28,740,681 This section, the researcher reviews the already examined literature in formulating the hypothesis concerning the relationships that exist amid financial institutions’ governance and their liquidity creation. It also looks at the effects of financial institutions capital on bank creation in the process of controlling their internal management. The study looks at the existing liquidity creation literature and tries to develop the growing bank governance literature. Indeed the financial institutions perform a critical role in the economy by creating liquidity loans associated with deposits. This can be done through corporate lending through customary enterprises’ loans and loan commitments. These are very crucial economic aspects in boosting the economic activities of a state. During the research, the empirical studies showed the way bank liquidity creating are still low though is growing at a higher rate. The study emphasizes the importance of filling the gap of insufficient bank liquidity creation through practical measures which include cat fat, cat nonfat, mat fat and nonfat measures. These actions are applied about categories of loans or their maturities. The research establishes that the empirical liquidity creation can use these standards and also to look for the necessary connections between equity capital and liquidity creations. This research also strives to establish the impacts of monetary policy with regards to the economic outputs. This liquidity intervention is done by the government to with the aim of saving the liquidity financial crisis. This study majorly forwards the possible suggestions which can be used to avoid the liquidity crisis (Krishnamurthy 15). Findings and results The results are represented in the table above outlining the descriptive statistics for the variables. These descriptive statistics provides a sample data of the periods 2003 and 2013 for every financial institution that was studied. These columns represent the statistics that were obtained with the aim of analyzing the liquidity crisis. The second column represents the statistics that were collected from the first quarter of the year 2009 whereas the third column represents the data that were obtained from the first three months of the year 2010 and it extends to the fourth quarter of the year 2013. These data shows that all these financial institutions that were studied created an average of between $5.4 and $ 5.4 billion which were measured with regards to cat fat and cat nonfat liquidity categories respectively. The study also established the obvious differences that exist amid these averages mentioned above created by the large financial institution and the small financial institutions which reached 12 billion. This similar trend is also seen in case the study compares the financial institution's liquidity based on the liquidity levels (Levine 950). The research established that the highest liquidity creators targeted $35 billion averagely; on the other hand, the lowest liquidity creators merely produced $80 million on average. This variation in liquidity creation between these two financial institutions is very substantial. This study establishes that the high liquidity standard deviation of the greatest financial system creators to be near $103 billion on average. However, the standard deviation of cat fat of the lower financial liquidity to be only $2 million. The general governance score is indicated to 17.6 in the year 2003 and 2013 in average. This ranges from 13.3 and 20.1 for low and high liquidity creators respectively. However, the high and low financial institution liquidity creators have failed to exhibit significant differences amid their governance scores with the largest financial institutions registering a score of 18.7 and the lowest recording 17 (Loutskina 680). The average score for z in more strong financial institutions is 34 and 35 for the smaller financial institutions. The z-score shows greater stability and the distance evasion as the ratings go up. This average in deviation proves that the smaller banks are likely of being real table compared to the larger banks. The equity proportions as shown in the empirical table below are 10.69%, 10.21% and 12.20 % for the more major, medium and small financial institutions respectively. The equity proportions for the larger financial institutions liquidity creators’ touches 11%/. The lower liquidity creators also the biggest equity proportions averagely affecting nearly 11.8%. A keen observation of these invariant empirical results shows a concurrence with the vulnerability hypothesis with liquidity creation and equity shifting positions. The empirical tabulation shows the credit risk proportions to be 76.5% averagely of the three kinds of financial institutions. This ratio is nearing the number for the larger, medium and high liquidity and lowers liquidity financial institutions. Nevertheless, the small financial institutions exhibit a proportional credit risk of 86% averagely with 10% points higher above the average financial institution's data collected. The ROA and the ROE axes show matching trends for all the financial institutions irrespective of their sizes. The average ROA and the average ROE are 0.47% and 4.95% respectively for all the financial institutions as per the data collected. The tables show the variations in governance scores after and before the liquidity crisis. Averagely the empirical study establishes that the financial institution ratings go up between 2003 and 2007 with nearly 28 after the year 2009 and with a huge variation during the years 2010 and 2013. The empirical study show that the governments score during these years concerning reducing liquidity risks is nearly 17%. This average can be said to be a little bit smaller as compared to the values of non-financial organizations as reported by the studies. These financial organizations registered a score of between 20% and 30% (Douglas and Philip 500). Conclusion Indeed as it has been motioned above, the financial institutions play two primary roles in an economy which includes converting the liquidity risks into economic growth and also creating liquidity. The earlier research showed that conversion of risks to economic growth could negatively impact on the bank since all these are just risk taking processes. Risk talking can lead to failure of bank regulation if not given much attention by the bank itself. However, the study establishes that majority of the banks have not been able to exploit their risk-taking approaches as expected. This has been the reason why the financial institutions experienced a lot of liquidity crisis between the years of 2003 and 2013 in the American financial sector. Among the findings is that the financial institution's liquidity creations went up due to excellent governance between the years of 2003 and 2009 and also another significant growth in liquidity was experienced in the year 2007 and 2009. Moreover, the research also established the importance of corporate governance concerning liquidity creation. This corporate governance keeps only changing depending on the size and the ability of the financial institution to create more liquidity. The bank holding companies with a well established shareholding base can create a lot of liquidity as compared to those financial institutions with weak shareholding protection systems. The deep analysis of the two category measures of cat fat and nonfat governance systems provided the additional support to come up with the first hypothesis. The research established that right CEO’s can score high due to high liquidity creation results as compared to the weak ones who score very low marks about liquidity creation. These highly ranked CEO’s can introduce greater incentives, and good practices in their financial institutions resulting into higher performance regarding liquidity creations. The research further looked at the banks that create the highest liquidity and the least liquidity creators on size. The most top liquidity creators are found to be experiencing good governance regarding liquidity creation whereas the lower liquidity creators’ experience weak management systems. Works Cited Berger, Allen N., and Gregory F. Udell. "The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle." Journal of banking & finance 22.6 (1998): 613-673. Cornett, Marcia Millon, et al. "Liquidity risk management and credit supply in the financial crisis." Journal of Financial Economics 101.2 (2011): 297-312. Campello, Murillo, et al. "Liquidity management and corporate investment during a financial crisis." Review of Financial Studies 24.6 (2011): 1944-1979. Diamond, Douglas W., and Philip H. Dybvig. "Bank runs, deposit insurance, and liquidity." Journal of political economy, 91.3 (1983): 401-419. Gillan, Stuart, and Laura T. Starks. "Corporate governance, corporate ownership, and the role of institutional investors: A global perspective." 2003. Krishnamurthy, Arvind. "Amplification mechanisms in liquidity crises." American Economic Journal: Macroeconomics 2.3 (2010): 1-30. Levine, Ross. "Finance and growth: theory and evidence." Handbook of economic growth 1 (2005): 865-934. Loutskina, Elena. "The role of securitization in bank liquidity and funding management." Journal of Financial Economics 100.3 (2011): 663-684. Read More