Do banks have more incentives to create liquidity? Evidence from terrorist attacks around the world

Abstract

This study examines the impact of terrorism on bank liquidity creation using a sample of 17,561 commercial banks in 126 countries over the period 2011-2021. We provide empirical evidence that terrorism exerts positive influence on bank liquidity creation across both on- and off-balance-sheet activities, as well as on the asset and liability sides. This baseline result still remains robust and statistically significant after employing IVs regression, GMM, and DiD analysis. Further analysis suggests risk- taking level as the possible mechanism driving this influence. Moreover, we find that the positive effect of terrorism on bank liquidity creation is more pronounced at banks exhibiting high non-performing loans, large size, low capital, and low profitability. Additionally, in countries where banking regulations and supervision promote high private monitoring, low activity restrictions, minimal official supervisory power, and relaxed capital regulations, the positive relationship between terrorism and bank liquidity creation is also more pronounced. Managers should strategically prepare banks to handle the increase in both liquidity supply and demand during terrorism by enhancing digital infrastructure, offering tailored services, diversifying risks, and utilizing historical data to design customized credit solutions, thereby balancing opportunity and risk while maintaining profitability and stability.