The interrelationship between liquidity creation and bank capital in Vietnamese banking

Abstract

Purpose: The purpose of this paper is to investigate the interrelationship between liquidity creation (LC) and bank capital in Vietnamese banking between 2007 and 2015. Design/methodology/approach: 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. Findings: 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. Practical implications: 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. Originality/value: 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. © 2018, Emerald Publishing Limited.