DP14956 Liquidity Creation, Investment, and Growth

Author(s): Thorsten Beck, Robin Döttling, Thomas Lambert, Mathijs A Van Dijk
Publication Date: June 2020
Keyword(s): Banking sector development, economic growth, investment, liquidity creation, tangible assets
JEL(s): E22, G21, O16, O40
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14956

Liquidity creation (the transformation of liquid liabilities into illiquid assets) is a key function of banks. We show that liquidity creation is positively associated with economic growth at both country and industry levels. In particular, liquidity creation helps growth by boosting tangible, but not intangible investment. Our results suggest an important non-linearity; liquidity creation does not contribute to growth in countries with a higher share of industries relying on intangible assets. We rationalize these results using a model in which banks increase aggregate investment by reducing liquidity risk, but low asset tangibility hampers liquidity creation by exacerbating moral hazard problems. Together, these findings provide new insights into the functions of banks, but also highlight their more limited role in supporting innovative industries.