The Impact of Bank Liquidity Risk on Risk-Taking and Bank Lending : Evidence from European Bank

Objective - This paper uses a sample of annual observations of European banks to examine whether the liquidity risk affects a bank's risk-taking behavior and its future loan growth.Methodology – A sample of European banks (27 member countries of the European Union plus U.K.) over the period of 2005 to 2019 are used in this study. Liquidity risk is measured by the ratio of liquid assets to total assets. Given the longitudinal nature of the data, the authors use panel regression with bank fixed effects to control for unobserved characteristics that might affect the dependent variable.Findings – The authors find that banks holding more liquid assets take less risk and show a higher subsequent loan growth rate. These results hold for both small and large banks.Novelty – To the authors' best knowledge, this is one of the earliest studies to carefully examine the effects of liquidity risk on risk-taking behavior and loan growth rate for European banks. Our research suggests that the current Basel III requirement on liquidity ratio can decrease bank's risking-taking behavior while not necessarily impact their future loan growth.Type of Paper - Empirical