Liquidity : How Banks Create It and How It Should Be Regulated

Liquidity creation is a core function of banks and an economic service of substantial importance to the economy. This chapter reviews and synthesizes the theoretical and empirical literature on bank liquidity creation. The focus is on the economics of bank liquidity creation, both in the traditional relationship banking context and in the shadow banking context. The related prudential regulation issues – pertaining mainly to capital requirements and liquidity requirements – are also discussed. A historical overview is provided, starting in the early 1800s and ending with Basel III and the Dodd-Frank Act. Open research questions are identified