LIQUIDITY RISK AND BANK PERFORMANCE: Evidence from European Publicly Listed Banks

Abstract

The purpose of this paper is to investigate the relationship between banks’ liquidity and performance around the financial crisis of 2007. The data that is used to conduct research include observations from 95 banks in 13 different European countries between 2006–2015. The empirical section is conducted by using fixed effects panel regression method for data that is gathered from Bankscope database. Liquidity is measured by two different key ratios, while bank performance is measured via three different key ratios. Moreover, bank specific and macroeconomic control variables are incorporated into the study. Furthermore, the effects of liquidity on banks’ performance are also studied in different economic circumstances before, during and after the financial crisis of 2007. Also, the size of a bank is controlled in regressions.

In general, the results of the relationship between liquidity and bank performance are mixed. Before the crisis, there is a minor negative relationship between the determinants of bank performance and liquidity. However, during the financial crisis when the world economy is in a fragile state, the relationship is positive. It indicates that the proper liquidity risk management tools have a positive effect on bank performance during the difficult times. Moreover, after the crisis, the relationship is mainly insignificant. Additionally, large banks have higher statistical significance levels during all periods than small banks.

For further examination, a larger sample size and longer period before the financial crisis might contribute more for financial research. In this study, the regressions get decent R-squared values, but still, a larger sample size would benefit significance of the research. Also, adding more precise measurements of liquidity, and liquidity risk management by calculating balance sheet items as per their liquidity risk coefficients would help to gain more accurate results.

Finally, this study provides evidence that liquidity has effected banks’ performance around the financial crisis of 2007 as presumed in previous literature considering the relationship between banks’ performance and liquidity risk management. Soon, the effects of the Basel III regulations to bank performance can be observed.