BANK COMPETITION AND FINANCIAL STABILITY: LIQUIDITY RISK

PERSPECTIVE

JEONGSIM KIM∗

We study whether competition affects banks’ liquidity risk-taking, which was at the
heart of the 2008 financial crisis. We find that banks with greater market power take
more liquidity risk, implying that decreased competition leads to financial fragility.
During a financial crisis, however, the effect of market power on liquidity risk varies
across bank size. Small banks with greater market power reduce liquidity risk while large
banks with greater market power do not change their liquidity risk-taking behavior. This
suggests that enhanced charter values due to reduced competition lowers small banks’
risk-shifting incentives when their default risk significantly increases during a crisis.
(JEL G21, G28)

I. INTRODUCTION questions. First, does competition affect banks’

Although the effect of bank competition on
financial stability has long been a subject of
interest to both researchers and policy makers,
the 2008 global financial crisis reminds us that
more research is needed on this issue. Exten-
sive previous studies have focused on the impact
of competition on bank risk-taking in the form
of credit or default risk. Not much attention has
been paid to the role of competition in liquidity
risk-taking,1 despite its central part in the devel-
opment of the unprecedented crisis. A number
of banks failed during the crisis because they
were engaged in excessive liquidity risk-taking
(Acharya and Naqvi 2012; Brunnermeier and
Oehmke 2013; Farhi and Tirole 2012).
This paper attempts to fill this gap in the
literature by exploring the following three
∗ Thiswork was supported by the National Research
Foundation of Korea Grant funded by the Korean Government
(NRF-2014S1A5B8060964).
Kim: Research Professor, College of Economics,
Sungkyunkwan University, 25-2, Sungkyunkwan-ro,
Jongno-gu, Seoul 03063, Korea. Phone +82-2-760-0825,
Fax +82-2-760-0950, E-mail js.kim@skku.edu
1. In this paper, we focus on funding liquidity risk, which
is the risk where a bank has difficulty in meeting creditors’ (or
borrowers’) demands for their money (Allen and Gale 2004;
Bryant 1980; Diamond and Dybvig 1983; Diamond and Rajan
2001). Funding liquidity risk arises from a bank’s inability to
liquidate assets promptly or obtain sufficient funds to settle
its obligations, whereas market liquidity risk is the risk in
which banks are forced to sell assets at fire-sale prices due
to serious deterioration of market conditions (Brunnermeier
and Pedersen 2009).
liquidity risk-taking behavior? There are two
conflicting hypotheses. On the one hand, compe-
tition contributes to lower liquidity risk because
banks with greater market power take on more
liquidity risk by granting more loans and reduc-
ing liquid reserves (Carletti and Leonello 2014;
Petersen and Rajan 1995). Strengthened market
power increases opportunity costs of holding
liquid assets as loans become more profitable.
On the other hand, competition leads to higher
liquidity risk because competition destroys a
bank’s charter value and thus compels it to take
on more liquidity risk. Keeley (1990) shows that
competition encourages banks to take excessive
risk by reducing their capital buffers and creating
risk-shifting incentives.
ABBREVIATIONS
2SLS: Two-Stage Least Squares
FE: Fixed Effects Model
GDP: Gross Domestic Product
GMM: Generalized Method of Moments
HHI: Herfindahl–Hirschman Index
IFS: International Financial Statistics
IMF: International Monetary Fund
IV: Instrumental Variables
M&A: Mergers and Acquisitions
OECD: Organization for Economic Co-operation and
Development
TBTF: Too-Big-to-Fail
TOC: Total Operating Costs
WDI: World Development Indicators
WGI: Worldwide Governance Indicators
WLS: Weighted Least Squares

doi:10.1111/coep.12243
Contemporary Economic Policy (ISSN 1465-7287) © 2017 Western Economic Association International
2 CONTEMPORARY ECONOMIC POLICY
Our next question is concerned with how
competition affects bank liquidity risk during a
crisis. An understanding of the effect of competi-
tion policy during a crisis is essential to restore
financial stability as well as to prevent another
crisis. Particularly, stability issues and market
power concerns are acutely conflicting during
times of market stress. Essentially, banks suf-
fer from reduced charter values during a cri-
sis. In this situation, more intense competition
aggravates the problem. This may lead banks
to take higher liquidity risk due to risk shift-
ing in a more competitive market during a crisis
(Hakenes and Schnabel 2010; Jensen and Meck-
ling 1976; Stiglitz and Weiss 1981). Implicit or
explicit guarantees enable banks to behave pru-
dently by reducing the risk-shifting incentives.2
However, public guarantees pose another prob-
lem, namely that of moral hazard. They distort
competition and disturb the level playing field in
the banking system, as protected banks are able
to have lower funding costs (Akins et al. 2016;
Beck et al. 2010; Gropp, Hakenes, and Schnabel
2011). Therefore, guaranteed banks are expected
to take higher liquidity risk through increasing
both lending and funding.
Our last question is concerned with how the
effect of competition on banks’ liquidity risk-
taking varies across bank size during a crisis. The
large and small banks have different character-
istics in terms of business strategies or funding
structures. A more pronounced feature of large
banks is that they are more likely to be publicly
guaranteed than small banks during a crisis (Boyd
and Gertler 1994; Hughes and Mester 2013;
O’Hara and Shaw 1990; Vives 2011). Therefore,
large banks may have less incentive to behave
prudently when their market power increases dur-
ing the period of economic turbulence. That is,
large banks with greater market power have an
incentive to take more liquidity risk due to moral
hazard. In contrast, small banks with greater mar-
ket power reduce liquidity risk exposure in order
to protect their enhanced charter value. To put
it differently, intense competition during a cri-
sis aggravates the risk-shifting problem of small
banks, which already suffer from reduced char-
ter value due to the sluggish economy, and thus
forces them to take more liquidity risk.
2. In fact, numerous countries provided extensive bailout
programs during the recent crisis to stabilize the economy.
Northern Rock was nationalized by the British government
in 2008. UBS (Switzerland), Citibank (US), and Fortis (Bel-
gium, Luxembourg, Netherlands) were also bailed out during
the crisis.
From a panel dataset that was constructed for
10,979 banks in 25 Organization for Economic
Co-operation and Development (OECD) coun-
tries from 2000 to 2014, we find that market
power is positively associated with liquidity risk,
suggesting that competition is beneficial to finan-
cial stability. This result is robust even after con-
trolling for endogeneity concerns. During a crisis,
however, the effects of market power on liquid-
ity risk are different for large and small banks:
the positive effect of market power on liquidity
risk remains unchanged for large banks, whereas
the positive effect weakens for small banks, espe-
cially for very small banks, in which their default
rate increases significantly. In other words, com-
petition is desirable for financial stability of large
banks but, in contrast, it is harmful for financial
stability of small banks during times of financial
turbulence. These results imply that enhanced
market power during a crisis helps small banks
behave prudently to protect their increased char-
ter values, whereas it makes large banks subject
to moral hazard.
We address potential endogeneity problems
because market power and liquidity risk may
be jointly determined. For example, a bank tak-
ing higher liquidity risk—through granting more
loans and credit lines—can gain more market
power. To address the potential endogeneity, we
perform instrumental variables (IV) regressions
using a generalized method of moments (GMM)
estimator. We employ entry barriers and control
of corruption as IV of market power.
Additionally, we conduct a variety of robust-
ness checks to ensure the validity of our results.
We employ the dynamic panel GMM esti-
mator to control for the dynamic relationship
between competition and bank liquidity risk as
well as the panel Tobit analysis to account for
left-censored observations of some dependent
variables. Furthermore, we control for several
bank characteristics, country characteristics, and
macroeconomic conditions, including market
liquidity risk, because a bank’s liquidity risk is
affected by fluctuations in market-wide liquidity.
Our finding that competition is beneficial for
financial stability in terms of bank liquidity risk
is highly robust across multiple econometric
specifications, liquidity risk and competition
measures, and control variables.
This study contributes to the previous liter-
ature in three ways. First, to the best of our
knowledge, this is the first study to empiri-
cally investigate the relationship between com-
petition and stability from the perspective of
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK
liquidity risk. Second, our study contributes to
the competition-stability strand in the literature
by further extending the scope of stability to
include liquidity risk because previous litera-
ture has mainly focused on credit or default
risk. Finally, we add to the liquidity risk lit-
erature by considering competition as a main
driving force that affects a bank’s liquidity risk-
taking behavior.
The remainder of the paper proceeds as
follows. Section II reviews the literature and
develops our hypotheses. Section III describes
methods of constructing measures for liquidity
risks and market power. Section IV explains
the data and empirical strategies. Section V
presents the empirical results. Section VI pro-
vides robustness checks. Section VII concludes
the paper.
II. LITERATURE REVIEW
What is liquidity risk in banking? Liquid-
ity risk for a bank is the risk where a bank is
unable to settle its obligations in a timely man-
ner when depositors attempt to withdraw funds.
This liquidity risk stems from banks’ liquidity
creation function wherein banks create liquidity
by transforming illiquid assets into liquid demand
deposits (e.g., Diamond and Dybvig 1983). How-
ever, this fundamental role makes banks vul-
nerable to liquidity risk because the customers’
demand for funds may arise at an inconvenient
time, thereby making it difficult for banks to meet
its obligations by liquidating illiquid assets with
immediacy (Allen and Gale 2004; Diamond and
Rajan 2001). Therefore, banks hold liquid assets
in order to manage their liquidity risk.
Traditionally, bank liquidity risk was consid-
ered to originate from a bank’s role as a liq-
uidity creator in relation to demand deposits. In
recent years, however, liquidity risk from demand
deposits has not been severe because deposits
are protected by insurance in most countries.3
Recent studies pay attention to liquidity risk
that stems from committed credit lines (Holm-
ström and Tirole 1998; Kashyap, Rajan, and
Stein 2002). A line of credit gives a borrower
an option to draw down funds at any time dur-
ing the period of the contract. That is, credit
lines also leave banks fragile to liquidity risk.
After the failure of Lehman Brothers in 2008,
3. In fact, deposits rather flow into banks to search for
safe havens during a crisis (Acharya and Mora 2015; Gatev,
Schuermann and Strahan 2009; Gatev and Strahan 2006).
3
banks experienced runs by borrowers who drew
down their existing lines of credit (Cornett et al.
2011; Ivashina and Scharfstein 2010). Therefore,
we focus on liquidity risks in the form of com-
mitted credit lines, liquidity creation, and liquid
asset holdings.
Competition particularly matters in the bank-
ing sector because banks are inherently exposed
to the risk of instability and systemic financial
crises (Claessens and Laeven 2004; Vives 2011).
Like other industries, competition enhances effi-
ciency, innovation, and the quality of products.
However, more importantly for the banking sec-
tor, the degree of competition is closely related
to banks’ risk-taking behavior, which affects the
stability of the economy. Because of the impor-
tance of competition policy, there has been rich
research studying the relationship between com-
petition and financial stability (Carletti 2008;
Zigraiova and Havranek 2016). However, previ-
ous studies provided mixed findings about the
relationship. Some studies argue that higher com-
petition leads to financial fragility (e.g., Keeley
1990); whereas others suggest that more com-
petition contributes to stability (e.g., Boyd and
Nicoló 2005).
The “competition-fragility” view is based on
the idea that more intense competition erodes
bank charter values, and thus decreases their
incentives to behave prudently (Hellmann, Mur-
dock, and Stiglitz 2000; Keeley 1990; Marcus
1984; Matutes and Vives 1996). According to
the charter value hypothesis, banks restrain their
risk-taking to protect monopoly rents from bank
charters. The decrease in charter value leads
banks to take excessive risk because it reduces
the penalty from bank failure. Keeley (1990)
finds that increased competition attributable to
deregulation in the 1980s reduces bank capi-
tal buffers and thus increases the probability
of default. Repullo (2004) shows that greater
market power reduces banks’ gambling incen-
tives. Using data on 69 countries from 1980
to 1997, Beck, Demirgüç-Kunt, and Levine
(2006) find that banking crises are less likely
to occur in economies with more concentrated
banking systems.
The “competition-stability” view, however,
challenges the conventional view. Boyd and
Nicoló (2005) show that more market power
results in higher loan rates, which lead borrowers
to choose more risky investments. Consequently,
this results in higher risk of bank failures.
Boyd, Nicoló, and Jalal (2007) and Nicoló
and Loukoianova (2007) provide an empirical
4 CONTEMPORARY ECONOMIC POLICY
evidence that banks are more likely to take
greater risk in a less competitive banking system.
Carletti and Leonello (2014) argue that competi-
tion enhances stability in terms of bank liquidity
risk. Greater market power increases opportunity
costs of holding liquid assets as loans become
more profitable, which lead banks to take more
liquidity risk.
Is competition desirable or detrimental to
stability during crises? In times of financial
turmoil, the trade-off between market power
concerns and stability considerations become
particularly acute. Some studies argue that
competition should not be suppressed due to
the positive impact of a crisis on the economy
through its disciplinary role, while others argue
that protecting the system by avoiding conta-
gion of bank failure dominates market power
concerns during times of market stress (Vives
2011). During a crisis, competition may place a
higher burden on banks through its destruction
of monopoly rents.
Governments provide various guarantee pro-
grams in order to prevent negative economy-wide
externalities and to stabilize the economy dur-
ing crises. However, stability through govern-
ment guarantees comes at a cost. Those programs
impede fair competition and disturb level playing
fields in the banking system, as publicly guaran-
teed banks are able to have lower cost of capi-
tal (Akins et al. 2016; Beck et al. 2010). Large
banks are more likely to be protected because
they are more systemically important than small
banks (Boyd and Gertler 1994; O’Hara and Shaw
1990). Using a panel dataset for U.S. commercial
banks from 2006 to 2012, Kim and Joh (2015)
find that most failed banks were small while
no too-big-to-fail (TBTF) banks failed during
the recent financial crisis. Therefore, the effect
of competition on financial stability may vary
across bank size. Protected banks attempt to take
advantage of their monopoly rents from govern-
ment guarantees (Gropp, Hakenes, and Schnabel
2011). In the presence of this kind of moral haz-
ard, competition is expected to be beneficial to
stability of large banks by mitigating the moral
hazard problem. In contrast, small banks, which
are less likely to be publicly guaranteed, are sub-
ject to the risk-shifting problem due to lower
charter values during times of turbulence. In this
situation, higher competitive pressure deterio-
rates small banks’ charter values more signifi-
cantly. Therefore, competition is expected to be
harmful for the stability of small banks during
the crisis.
III. MEASUREMENTS OF LIQUIDITY RISKS AND
COMPETITION
A. Liquidity Risk Measures
A growing literature has tried to develop con-
crete liquidity risk measures, in response to the
growing interest in liquidity risk in the aftermath
of the recent financial crisis. However, there is
still a lack of consensus on the empirical mea-
sure for liquidity risk (Drehmann and Nikolaou
2013; Soula 2015). In the past, liquidity risk
measures mostly focused on the use of liquid-
ity ratios—such as the share of liquid (illiquid)
assets in total assets—based on the bank bal-
ance sheet data (e.g., Molyneux and Thornton
1992). For instance, more cash and other liq-
uid assets as a buffer make banks less vulner-
able to liquidity risk. Similarly, more illiquid
assets, which are difficult to liquidate promptly
during a crisis, expose banks to greater liquid-
ity risk. Although the liquidity of assets is not
a direct measure of liquidity risk, these liquid-
ity ratios are widely used as proxies for liquidity
risk because they represent the exposure to liq-
uidity risk from the asset side (Shen et al. 2009).
Recent empirical studies have focused on liq-
uidity risk from undrawn credit lines, which are
held off the balance sheet (Cornett et al. 2011;
Gatev, Schuermann, and Strahan 2009). In addi-
tion, Berger and Bouwman (2009) developed liq-
uidity creation measures considering the on- and
off-balance sheet positions. Although Berger and
Bouwman’s (2009) measures comprehensively
reflect the magnitude of liquidity creation, the
weights assigned by them to construct liquidity
creation measures are not time varying depend-
ing on market conditions (Krishnamurthy, Bai,
and Weymuller 2016). Therefore, the develop-
ment of concrete liquidity risk measures is still
open to debate.
To check the robustness of our empirical
results, we consider the three types of liquidity
risks simultaneously: committed credit lines,
liquid asset holdings, and liquidity creation.
We calculate our liquidity measures as follows.
First, liquidity risk from committed credit lines
is calculated by expressing committed credit
lines as a fraction of total assets plus committed
credit lines, following Cornett et al. (2011).
Second, liquidity risk from the magnitude of
liquid reserves is calculated as the ratio of liquid
asset holdings to total assets. The estimated
coefficients of liquid asset holdings are expected
to have opposite signs of other liquidity risk
measures because the more liquid assets a bank
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK
holds, the lower liquidity risk the bank has.
Finally, liquidity risk from liquidity creation is
calculated as the Berger and Bouwman’s (2009)
liquidity creation measure divided by total assets.
We construct their preferred “cat fat” liquidity
creation measure using the following three-step
procedures. First, we classify all on- and off-
balance sheet activities4 as illiquid, semi-liquid,
and liquid depending on the ease, cost, and time
for customers to obtain liquid funds from the
bank (liability side) and the ease, cost, and time
for banks to dispose of their obligations (asset
side). Second, we assign weights to all the activ-
ities classified in the first step. The weights are
based on the liquidity creation theory according
to which liquidity is created when illiquid assets
are transformed into liquid liabilities, whereas
liquidity is destroyed when liquid assets are
transformed into illiquid liabilities or equity. In
the final step, we calculate the level of liquidity
creation by combining all activities, which are
classified in step 1 and then weighted in step 2.
B. Competition Measure: Lerner Index
There is no perfect measure for competition
between banks, although previous literature has
used a variety of competition measures. The most
widely used measures are the market structure
measures (such as the Herfindahl–Hirschman
Index [HHI], number of banks, and concentration
ratios), Lerner index, Boone (2008) indicator, and
Panzar and Rosse (1987) H-statistic (Zigraiova
and Havranek 2016). Among these measures, we
employ the Lerner index as the main competition
measure. In addition, we re-estimate our baseline
models of Equation (4) by employing the Boone
indicator to check for the robustness of our results
(Table 10).
The Lerner index, which is a measure of mar-
ket power, captures a bank’s pricing power of
charging price above its marginal cost. It has the
following advantages as a proxy of competition
compared to other competition measures. First,
the Lerner index is a more direct proxy to mea-
sure bank market power, which conforms to the
notion of the charter value hypothesis. In contrast,
the market structure measures do not directly
link to price levels due to a bank’s competitive
behavior. Claessens and Laeven (2004) and Beck,
4. Berger and Bouwman (2009) suggest that both on- and
off-balance sheet activities should be considered to precisely
measure the degree of liquidity creation. Among their four
measures of liquidity creation, the “cat fat” measure considers
both the on- and off-balance sheet activities simultaneously.
5
Demirgüç-Kunt, and Levine (2006) find no evi-
dence that competition is negatively associated
with market concentration. Second, the Lerner
index allows us to calculate the degree of market
power as in the bank-year observation, although
other competition measures are calculated as in
the country-year level. The country-year level
variables do not consider the fact that banks
often compete across national borders. Finally,
the Lerner index does not impose certain restric-
tive assumptions, unlike, for example, the H-
statistic, which requires that the banking market
be in long-run equilibrium (Bikker, Shaffer, and
Spierdijk 2012).
Following Berger, Klapper, and Turk-Ariss
(2009), we construct the Lerner index as follows
pit − MCit
(1) Lernerit =
pit
where Lernerit denotes the Lerner index for
bank i in year t. pit indicates the output price,
which is calculated as total revenues divided by
total assets. Total revenues include both interest
income and noninterest income, since a bank’s
revenues come from both activities. MCit is the
marginal cost at the current output level, derived
from the following translog cost function. We
modify the translog cost function by Berger,
Klapper, and Turk-Ariss (2009) to control for the
effect of risk, by adding nonperforming loans
ratios and bank capital as proxies of risk pre-
mium in the control variables set.5 A bank’s cost
depends on its risk exposure, reflecting a bank’s
business strategy or economic environments
such as a financial crisis (Hughes and Mester
2013; Hughes, Mester, and Moon 2001; Jiménez,
Lopez, and Saurina 2013; Oliver, Fumas, and
Saurina 2006).
α
(2) ln TOCit = α0 + α1 lnTAit + 2 lnTA2it
2
∑
3
∑
2
+ δk lnωkit + λh lnRhit
k=1 h=1
∑3
∑
2
+ ξk lnTAit lnωkit + ψh lnTAit lnRhit
k=1 h=1
5. To check the robustness of our findings, we re-estimate
all empirical models by using only nonperforming loans ratios
(excluding bank capital) or by replacing nonperforming loans
ratios with loan-loss provision ratios as a proxy for risk
premium in Equation (2). We also re-estimate our empirical
models without any risk proxies (Rhit ), as in Berger, Klapper,
and Turk-Ariss (2009). Our findings continue to hold in all
cases.
6 CONTEMPORARY ECONOMIC POLICY
∑ ∑
3 3
+ ρkj lnωkit lnωjit
k=1 j=1
∑ ∑
3 2
+ ζkh lnωkit lnRhit
k=1 h=1
∑ ∑
2 2
+ ϕhm lnRhit lnRmit + μt + ηit .
h=1 m=1
The marginal cost is defined as:
[
∂TOCit TOCit
(3) MCit = = ̂α1 + ̂
α2 lnTAit
∂TAit TAit
]
∑3
∑2
+ ̂ ξk lnωkit + ̂ h lnRhit
ψ
k=1 h=1
where TOCit indicates total operating costs. TAit
measures total assets, which is a proxy for a
bank’s output. ωkit represents input prices, which
includes the price of labor (the ratio of personnel
expenses to total assets), price of borrowed funds
(the ratio of interest expenses to total deposits
and money market funding), and price of fixed
assets (the ratio of other operating and admin-
istrative expenses to total assets), respectively.
Rhit indicates risk premium, which includes non-
performing loans ratios and bank capital. Time
dummies are included to control for changes in
technological and macroeconomic environments.
All standard errors are robust to heteroskedastic-
ity and are clustered by country to control for
serial correlation.
IV. DATA AND METHODOLOGY
A. Data
We construct a panel dataset for commercial
banks in OECD countries from 2000 to 2014.
The bank-level financial information is obtained
from the Bankscope database. The information
on merger and acquisition activities is collected
from Thomson’s SDC platinum database. The
data on gross domestic product (GDP) per capita
and GDP growth rates are from the World Devel-
opment Indicators (WDI). M2 is retrieved from
the International Monetary Fund’s International
Financial Statistics (IMF IFS). For our IV, infor-
mation on entry barriers and control of corruption
is collected from the databases provided by Barth,
Caprio, and Levine (2001, updated in 2003, 2008,
and 2012), and the Worldwide Governance Indi-
cators (WGI) developed by Kaufmann, Kraay,
and Mastruzzi (2011), respectively.
We apply multiple selection criteria. First,
banks with missing data on dependent, explana-
tory, and IV are deleted from the sample. Second,
banks with zero total assets, loans, deposits, and
equity are removed. Third, countries with fewer
than five banks are excluded from the sample.6
Finally, the bank-level financial statement vari-
ables are winsorized at the 1st and 99th percentiles
to account for the impact of outliers. The final
sample consists of 118,894 bank-year observa-
tions for 10,979 banks from 25 OECD countries,
spanning from 2000 to 2014.
B. Empirical Methods
In this study, we employ various economet-
ric methodologies: the fixed effects model as our
main empirical strategy,7 the IV analysis to mit-
igate endogeneity concerns, the dynamic panel
GMM estimations to account for the dynamic
aspect of the relationship between competition
and bank liquidity risk-taking, and the panel Tobit
regressions to control for left-censored observa-
tions of some dependent variables.
Our main empirical methodology is the fol-
lowing fixed effects model:
(4) Liquidity Riskijt = β0 + β1 Competitionijt
+ β2 Bankijt + β3 Countryjt + θi + τt + εijt
where Liquidity Riskijt denotes liquidity risk for
bank i from country j in year t; Competitionijt
denotes the degree of market power8 ; Bankijt
denotes bank-specific characteristics; Countryjt
country-specific characteristics; and εijt the error-
term.9 All regressions include bank fixed effects
(θi ) to capture time-independent differences
across banks, as well as time fixed effects (τt ) to
control for changes in the macroeconomic and
6. Eight countries—Austria, Chile, Estonia, Finland,
Greece, Iceland, Ireland, and New Zealand—are removed
from the initial sample.
7. We employ the fixed effects model instead of the ran-
dom effects model because the Hausman test for endogeneity
rejects the null hypothesis that unobserved individual effects
are uncorrelated with other regressors in the model.
8. We re-estimate our models, replacing the Lerner index
with the Boone indicator in Table 10. We find that our results
remain unchanged with the alternative competition measure.
9. We continue to find the same qualitative results even
after employing 1-year lagged values for competition (Com-
petitionijt − 1 ) to mitigate the impact of the potential endogene-
ity of market power.
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK
business environment common to all banks in
our sample. Robust standard errors are clustered
at the country level.
(5) Liquidity Riskijt = γ0 + γ1 Competitionijt
+ γ2 Crisist + γ3 Competitionijt ∗ Crisist
+ γ4 Bankijt + γ5 Countryjt + φi + υt + εijt
where Crisist is a dummy variable that equals
to one, if the year is 2008 or 2009. Compe-
titionijt * Crisist is an interaction term between
Competitionijt and Crisist . Bank fixed effects (φi )
and time fixed effects (υt ) are included in regres-
sions. εijt is the error-term. Robust standard errors
are clustered by country.
To address the endogeneity problem, we per-
form GMM estimations because this method
is more efficient than two-stage least squares
(2SLS) where there is heterogeneity of unknown
form. For the IV approach using a GMM estima-
tor, we employ entry restrictions (Entry Barriers)
and the control of corruption index (Control of
Corruption) as IV. The restriction on entry into
banking is a composite index that takes values
between 1 and 8. Higher values indicate greater
entry restrictions arising from legal requirements
for obtaining a banking license. Information on
entry barrier is obtained from Barth, Caprio, and
Levine (2001, and updated in 2003, 2008, and
2012). We use the values of 2012 as entry barri-
ers for the observations since 2012.10 The control
of corruption index captures the perceived levels
of corruption in a country, which has values from
−2.5 (weak) to 2.5 (strong). Higher values indi-
cate less corruption. In order to include bank fixed
effects in the GMM regressions, we choose IV
that have sufficient variations.
Another possible source of endogeneity is that
the current market power is a function of their
liquidity risk-taking in the past. To account for
the dynamic nature of the relationship between
competition and bank liquidity risk, we use the
dynamic panel GMM estimator developed by
Arellano and Bover (1995) and Blundell and
Bond (1998). The AR (1) and AR (2) show the
Arellano-Bond tests for first- and second-order
autocorrelation in the first-differenced residuals.
The Sargan test of over-identifying restrictions
examines the validity of IV.
In addition, we conduct the Tobit estimations
for Credit Lines and Liquid Assets because those
10. We re-estimate our model, excluding the entry bar-
riers. Our results when controlling only for the control of
corruption, which varies every year, as an IV continue to hold.
7
dependent variables are left-censored at zero. We
run panel Tobit regressions with random effects
and report the estimated marginal effects. For
dummy variables, the marginal effects are calcu-
lated as the discrete change in the expected value
of the dependent variable as the dummy variable
changes from 0 to 1. The ρ-statistic evaluates
whether the panel Tobit estimation is required.
When ρ is close to zero, the panel Tobit analy-
sis is not significantly different from the standard
Tobit analysis.
C. Variables
Table 1 shows definitions and data sources
of dependent, explanatory, and instrumental
variables. Specifically, Liquidity Riskijt includes
liquidity risks from committed credit lines
(Credit Lines), liquid asset holdings (Liquid
Assets), and liquidity creation (Liquidity Cre-
ation). The Lerner index is employed as a proxy
for market power (Competitionijt ).
The bank-specific factors include bank size
(Assets), bank credit risk (Nonperforming Loans
Ratios), equity ratio (Equity Ratios), and merg-
ers and acquisitions activities (M&A Activity).
Bank size, which is calculated as the natural log-
arithm of total assets, is included to capture dif-
ferences in risk management capabilities (Dem-
setz and Strahan 1997; Elsas, Hackethal, and
Holzhäuser 2010) and in the possibility of pub-
lic bailouts (i.e., TBTF policy) between large
and small banks. The squared bank size term
(Assets2 ) is also included to capture nonlinearity
in the effect of bank size on liquidity risk-taking.
Bank credit risk is measured by nonperforming
loans as a fraction of total loans. Nonperforming
loans may be negatively associated with liquidity
risk, because a bank with a high nonperforming
loans ratio is subject to suffering from the lack
of lending capacity or from holding more liquid
assets in order to improve its risk management.
The equity ratio is defined as the ratio of total
equity to total assets. The relationship between
bank equity capital and liquidity risk is ambigu-
ous. On the one hand, more capital leads to higher
liquidity risk as it improves a bank’s risk-bearing
capacity (Bhattacharya and Thakor 1993). On the
other hand, more bank capital results in lower liq-
uidity risk because the less fragile capital struc-
ture discourages the bank to create more liquidity,
which in turn encourages the bank to expropri-
ate rents from its customers (Diamond and Rajan
2001). M&A activity is a dummy variable that
equals one if a bank engages in one or more M&A
8 CONTEMPORARY ECONOMIC POLICY

TABLE 1
Variable Definition and Data Sources
Variables Definitions Sources
Panel A: Competition and Bank Liquidity Risk
Dependent variables
Credit Lines Liquidity risk from committed credit lines, calculated as the Bankscope
ratio of committed credit lines to total assets plus
committed credit lines. Higher values indicate more
liquidity risk.
Liquid Assets Liquidity risk derived from the extent to which a bank holds Bankscope
liquid assets, calculated as the ratio of liquid reserves to
total assets. Higher values indicate less liquidity risk.
Liquidity Creation Liquidity risk from liquidity creation, measured as the ratio Bankscope Authors’
of Berger and Bouwman’s (2009) “cat fat” liquidity calculations
creation measure, which is constructed by categorizing
all on- and off-balance sheet activities and then by
imposing weights on them, divided by total assets.
Higher values indicate more liquidity risk.
Explanatory variables
Lerner Lerner index, calculated as the difference between price and Bankscope Authors’
marginal cost divided by price. Higher values indicate calculations
more market power.
Assets Natural logarithm of total assets Bankscope
Nonperforming Loans Ratios Nonperforming loans as a fraction of total loans Bankscope
Equity Ratios Equity to total assets Bankscope
M&A Activity A dummy variable that takes a value of 1 if a bank was SDC Platinum
involved in one or more mergers and acquisitions over
the past 3 years
GDP per Capita Natural logarithm of GDP per capita WDI
GDP Growth Rates Annual percentage growth rate of GDP WDI
M2 to GDP M2 divided by GDP. M2 consists of M1, savings deposits, IMF IFS
money market deposit accounts, and time deposits.
Instrumental variables
Entry Barriers An index that takes values between 1 and 8, with higher Barth, Caprio, and Levine
values indicating greater entry restrictions (2001, updated in 2003,
2008, and 2012)
Control of Corruption An annual index that represents the level of control of WGI
corruption, ranging from −2.5 (weak) to 2.5 (strong).
Higher values indicate less corruption.
Panel B: Translog Cost Function
Log of Total Operating Costs Natural logarithm of total operating costs Bankscope
Price of Labor Personnel expenses to total assets Bankscope
Price of Funding Interest expenses to total deposits and money market Bankscope
funding
Price of Fixed Assets Other operating and administrative expenses to total assets Bankscope
Average Price of Bank Output Output price, calculated as total revenues divided by total Bankscope
assets
Marginal Costs Marginal costs, obtained from an estimated translog cost Bankscope
function with respect to bank output

Notes: This table provides the definitions and data sources for the variables used in the estimations. Panel A provides
information on the variables that are employed as dependent, explanatory, and IV in the competition-stability (bank liquidity
risk) regressions. Panel B shows information on the variables that are used to construct the Lerner index.

activities during the previous 3 years. It is added
to account for the impact of M&A events on cor-
porate strategies for liquidity risk management
(Carletti, Hartmann, and Spagnolo 2007).
The country-specific factors include the GDP
per capita (GDP per Capita), the GDP growth
rate (GDP Growth Rates), and the money sup-
ply (M2 to GDP). The GDP per capita and the
GDP growth rate are introduced to control for
the impact of economic development and of the
business cycle, respectively. The money supply
is included to capture the impact of the degree of
aggregate liquidity in a country.
Table 2 shows summary statistics for the
main variables we use in the empirical anal-
yses. Among our three dependent variables,
Credit Lines has 7,562 zero-value observations
in the sample. In unreported tests, we attempt
to mitigate the estimation problem arising from
these zero-value observations by re-estimating
regressions after dropping zero observations
of Credit Lines. In addition, we conduct Tobit
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK 9

TABLE 2
Summary Statistics
Variables Obs. Mean SD Min Max
Panel A: Competition and Bank Liquidity Risk
Dependent variables
Credit Lines 118,894 0.0824 0.0629 0 0.3276
Liquid Assets 118,894 0.1184 0.1276 0.0051 0.8242
Liquidity Creation 118,894 0.2950 0.2429 −0.3874 1.3312
Explanatory variables
Lerner 118,894 0.2183 0.1498 −0.4198 0.5464
Assets 118,894 12.186 1.6104 9.049 18.348
Nonperforming Loans Ratios 118,894 0.0160 0.0268 0.0002 0.1560
Equity Ratios 118,894 0.1114 0.0643 0.0223 0.7839
M&A Activity 118,894 0.0115 0.1066 0 1
GDP per Capita 118,894 10.6639 0.2289 8.4016 11.6855
GDP Growth Rates 118,894 0.0190 0.0167 −0.0780 0.1058
M2 to GDP 118,894 0.8768 0.4833 0.2319 6.8317
Instrumental variables
Entry Barriers 118,894 7.8068 0.4966 3 8
Control of Corruption 118,894 1.5162 0.3577 −0.7332 2.5506
Panel B: Translog Cost Function
Log of Total Operating Costs 118,894 9.0703 1.5708 5.8749 14.760
Price of Labor 118,894 0.0164 0.0133 0.0001 0.6137
Price of Funding 118,894 0.0180 0.0131 0.0008 1.1502
Price of Fixed Assets 118,894 0.0153 0.0305 0.0005 3.3135
Average Price of Bank Output 118,894 0.0620 0.0213 0.0152 0.1713
Marginal Costs 118,894 0.0484 0.0186 0.0100 0.1364

Notes: This table shows descriptive statistics for variables used in the regressions. The sample contains 10,979 commercial
banks in 25 OECD countries from 2000 to 2014. Panel A presents information on summary statistics of the variables used as
dependent, explanatory, and IV in the competition-stability (in terms of bank liquidity risk) regressions. Bank liquidity risk is
proxied for the exposure to credit-line drawdowns (committed credit lines), liquid asset holdings, and the degree of liquidity
creation. Panel B reports summary statistics of the variables employed to construct the Lerner index. Detailed information on the
variables is provided in Table 1.

regressions for Credit Lines and Liquid Assets
because those dependent variables are left-
censored at zero. According to Berger and
Bouwman (2009), banks with negative liquidity
creation (Liquidity Creation) may exist to per-
form the other crucial roles of banks, such as
risk transformation.
V. EMPIRICAL RESULTS
A. The Effect of Market Power on Liquidity Risk
Table 3 reports the results of the fixed effects
regressions on the relationship between market
power and liquidity risk (Equation (4)). Depen-
dent variables are liquidity risks, which stem
from committed credit lines, liquid asset hold-
ings, and liquidity creation.
In Model (1), we find that market power
(Lerner) is positively associated with liquidity
risk from credit lines (Credit Lines).11 This result
suggests that enhanced competition helps a bank
to reduce the exposure to liquidity risk, consis-
tent with Boyd and Nicoló (2005) and Carletti
and Leonello (2014). We allow for a nonlinear
relationship between bank size and liquidity risk
by using a squared term of bank size (Assets2 ).
The coefficient of the linear term (Assets) is
significantly positive, while that of the squared
term is significantly negative. Therefore, the bank
size exhibits a nonlinear relationship with liquid-
ity risk from committed credit lines. The coeffi-
cient of Nonperforming Loans Ratios is negative
(−0.2758) and statistically significant at the 1%
level, implying that banks with high credit risks
take less liquidity risk. Equity Ratios is positively
related to Credit Lines, implying that better capi-
talized banks take greater liquidity risk.
The remaining models confirm the results of
Model (1), using other liquidity risk measures
(Liquid Assets and Liquidity Creation) as depen-
dent variables. The results show that our find-
ings are pretty robust across various liquidity risk

11. We re-estimate regressions after dropping zero-value positive relationship between market power and liquidity risk
observations of Credit Lines in the sample. We again find the from undrawn credit lines.
10 CONTEMPORARY ECONOMIC POLICY

TABLE 3 B. The Impact of the 2008 Global Financial

The Effect of Market Power on Bank Liquidity Crisis
Risk In Table 4, we test whether the positive effect
Credit Liquid Liquidity of market power on liquidity risk changes dur-
Lines Assets Creation ing the financial crisis of 2008. To accomplish
(1) (2) (3) this, we add an interaction term (Lerner*Crisis)
Lerner 0.0262*** −0.0559*** 0.0687*** between Lerner and Crisis. Crisis is a dummy
(14.92) (−13.52) (5.59) variable that equals one if the year is 2008 or
Assets 0.0101* −0.0616*** −0.0013 2009. The coefficients of the crisis dummies
(2.06) (−5.92) (−0.04)
Assets2 −0.0005** 0.0016*** 0.0002 of Credit Lines and Liquid Assets are negative
(−2.38) (4.32) (0.13) (−0.0122) and positive (0.0962), respectively.
Nonperforming −0.2758*** 0.0448* −0.2996*** These results suggest that banks reduce their
Loans Ratios exposure to liquidity risks during a crisis.
(−6.13) (1.89) (−9.01)
Equity Ratios 0.0561*** −0.0276*** −0.1336**
Lerner*Crisis provides mixed findings. That
(7.17) (−3.08) (−2.46) is, the effect of market power on liquidity risk
M&A Activity 0.0001 0.0028 −0.0165** during the crisis is different depending on liquid-
(0.03) (1.16) (−2.78) ity risk measures. Specifically, the positive rela-
GDP per Capita 0.0180 −0.0495 −0.0305
(1.70) (−1.08) (−0.36)
tionship between market power and liquidity risk
GDP Growth −0.2002*** 0.8702*** −0.6370*** from committed credit lines is intensified during
Rates the crisis; the coefficient of Lerner*Crisis is pos-
(−3.31) (5.14) (−3.39) itive (0.0021) and statistically significant at the
M2 to GDP −0.0021 −0.0126 −0.0023
(−0.53) (−0.92) (−0.05) 5% level. In contrast to Model (1), Models (2)
Constant −0.1613 1.1155** 0.5840 and (3) for Liquid Assets and Liquidity Creation
(−1.33) (2.32) (0.63) provide evidence that the positive relationship
Bank fixed effects Yes Yes Yes between market power and liquidity risk weak-
Time fixed effects Yes Yes Yes
R2 0.1216 0.0698 0.1151
ens during the crisis; Lerner*Crisis is positively
Observations 118,894 118,894 118,894 (0.0160) related to Liquid Assets and negatively
(−0.0437) associated with Liquidity Creation.
Notes: This table shows fixed effects regression esti- These results suggest that banks with greater mar-
mates of market power on liquidity risk. The dependent vari- ket power decrease liquidity risk-taking by hold-
ables are liquidity risk from committed credit lines (Credit
Lines), liquid asset holdings (Liquid Assets), and liquidity cre-
ing more liquid assets and by reducing liquidity
ation (Liquidity Creation). Assets2 is the squared bank size creation during a crisis.
term. Detailed information on the variables is provided in What is the reason for these conflicting find-
Table 1. Robust standard errors are clustered by country. The ings? How do we reconcile them? To address
t-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, this issue, we focus on bank size. Particularly, we
5%, and 10% levels, respectively. focus on the difference in the possibility of being
publicly guaranteed depending on bank size. It is
well known that large banks are more likely to be
bailed out. Therefore, they may have less incen-
measures. Model (2) employs liquid asset hold- tive to behave prudently than small banks during
ings as a dependent variable. The estimated coef- the period of turbulence.
ficients of Liquid Assets are expected to have Table 5 reports the regression estimates of
opposite signs of other liquidity risk measures market power on liquidity risk, by dividing
because more liquid asset holdings mean lower banks into four groups, depending on their total
liquidity risk. Our results still strongly hold to assets, following Cornett et al. (2011).12 Panels
liquidity risk from the degree of liquid reserves. A and B show results for large banks (total assets
The coefficient of Lerner is negative (−0.0559) greater than US$1 billion) and medium banks
and statistically significant at the 1% level, sug- (total assets between US$500 million and US$1
gesting that banks hold fewer liquid assets as they
have greater market power. Model (3) for Liquid- 12. We re-estimate our models by dividing banks into
ity Creation provides the same results with pre- tercile, quartile, quintile, or decile groups depending on their
vious tests. Lerner is positively and significantly total assets per year in the corresponding country. We also re-
estimate our models by changing the definition of large banks
associated with Liquidity Creation, implying that to those with total assets greater than US$3 billion, US$10
banks with higher market power create more liq- billion, or US$50 billion. Our findings remain qualitatively
uidity, leaving them vulnerable to liquidity risk. unchanged.
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK 11

TABLE 4 risk regardless of unfavorable macroeconomic

The Effect of Market Power on Bank Liquidity conditions. This may be attributed to moral
Risk Considering the Impact of the 2008 hazard of large banks, taking advantage of public
Financial Crisis guarantees during times of crisis. Small banks
in Panel C, however, exhibit different liquid-
Credit Liquid Liquidity ity risk-taking behavior when they have more
Lines Assets Creation
(1) (2) (3) market power during a crisis. Small banks that
already suffer from reduced charter value due
Lerner 0.0258*** −0.0590*** 0.0773***
(15.47) (−13.58) (5.88)
to a sluggish economy seem to pursue safer
Crisis −0.0122* 0.0962*** 0.0066 strategies to preserve their charter values with
(−2.05) (4.51) (0.19) greater market power during a crisis.
Lerner*Crisis 0.0021** 0.0160*** −0.0437*** This tendency is more pronounced in very
(2.28) (3.99) (−7.28) small banks in which their default rate signifi-
Assets 0.0103** −0.0602*** −0.0051
(2.08) (−5.74) (−0.14) cantly increases during a crisis. For Model (1)
Assets2 −0.0005** 0.0015*** 0.0003 in Panel C2 for smallest banks, the coefficient
(−2.39) (4.17) (0.21) of Lerner*Crisis is significantly negative, while
Nonperforming −0.2756*** 0.0465* −0.3042*** that of Lerner is significantly positive; it sug-
Loans Ratios
(−6.13) (1.97) (−9.20) gests that the positive effect of market power
Equity Ratios 0.0563*** −0.0258*** −0.1385** on the exposure to undrawn credit lines reduces
(7.13) (−2.87) (−2.58) during a crisis. For Model (2) in Panel C2,
M&A Activity 0.0001 0.0028 −0.0164** Lerner*Crisis is positively (0.0184) and signifi-
(0.03) (1.14) (−2.75)
GDP per Capita 0.0180 −0.0497 −0.0299
cantly related to Liquid Assets, while Lerner is
(1.70) (−1.08) (−0.35) negatively (−0.0544) and significantly related to
GDP Growth −0.2000*** 0.8717*** −0.6413*** Liquid Assets. These results imply that, for very
Rates small banks, the negative effect of market power
(−3.31) (5.15) (−3.42)
M2 to GDP −0.0021 −0.0126 −0.0021 on holding liquid assets weakens during a crisis.
(−0.53) (−0.92) (−0.04) Consistent with the results of Models (1) and (2),
Constant −0.1624 1.1078** 0.6049 Model (3) shows that the positive effect of market
(−1.33) (2.31) (0.65) power on the degree of liquidity creation reduces
Bank fixed effects Yes Yes Yes
Time fixed effects Yes Yes Yes during a crisis. The coefficient of Lerner*Crisis
R2 0.1216 0.0699 0.1155 is negative (−0.0381) and statistically significant
Observations 118,894 118,894 118,894 at the 1% level.
Notes: This table reports fixed effects regression estimates
of market power on liquidity risk considering the impact of VI. ROBUSTNESS CHECKS
the 2008 global financial crisis. The dependent variables are
liquidity risks from committed credit lines (Credit Lines), To ensure the validity of our results, we con-
liquid asset holdings (Liquid Assets), and liquidity creation
(Liquidity Creation). Crisis is a dummy variable that equals duct a number of robustness tests by addressing
one if the year is 2008 or 2009. Lerner*Crisis is an interaction potential econometric concerns and employing
term between Lerner and Crisis. Assets2 is the squared bank additional control variables.
size term. Detailed information on the variables is provided in
Table 1. Robust standard errors are clustered by country. The
t-statistics are in parentheses. A. Endogeneity Issues
***, **, and * denote statistical significance at the 1%,
5%, and 10% levels, respectively. We confirm our findings using IV regressions
in Table 6. Panels A, B, and C provide the second-
stage regression results for all banks, large banks
billion), respectively. Panel C consists of Panel (total assets greater than US$1 billion), and small
C1 (small banks) and Panel C2 (smallest banks); banks (total assets less than or equal to US$100
small banks are those with total assets between million), respectively. The lower panel of the
US$100 million and US$500 million, while table shows the first-stage regression results for
smallest banks are those with total assets less our IV. The dependent variable of the first-stage
than or equal to US$100 million. regressions is Lerner. For the sake of brevity,
In Panel A for large banks, the coeffi- we do not separately report the first-stage regres-
cients of Lerner*Crisis in Models (1)–(3) sion tables except for the IV. We employ the
are insignificant. On balance, large banks with level of entry restrictions (Entry Barriers) and the
greater market power still take more liquidity control of corruption (Control of Corruption) in
 12
TABLE 5
The Effect of Market Power on Bank Liquidity Risk across Bank Size
Panel B: Medium Banks
Panel A: Large Banks (total assets US$500 million Panel C: Small Banks
(total assets > US$1 billion) to US$1 billion) (total assets ≤ US$500 million)
Panel C1: Small Banks
(total assets US$100 Panel C2: Smallest Banks
million to US$500 million) (total assets ≤ US$100 million)
Credit Liquid Liquidity Credit Liquid Liquidity Credit Liquid Liquidity Credit Liquid Liquidity
Lines Assets Creation Lines Assets Creation Lines Assets Creation Lines Assets Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.0344*** −0.0744*** 0.0693* 0.0414*** −0.0615*** 0.0478** 0.0376*** −0.0449*** 0.1043*** 0.0210*** −0.0544*** 0.0735***
(3.16) (−4.32) (2.04) (7.70) (−2.87) (2.09) (9.50) (−4.28) (10.14) (22.41) (−25.86) (17.30)
Crisis 0.0142 0.0656*** −0.0805 0.0098 0.0615* 0.1528** 0.0193 0.0044 0.0648 −0.0127** 0.0131 −0.1295*
(1.02) (3.23) (1.43) (1.04) (1.94) (2.64) (0.56) (0.29) (1.46) (−2.38) (0.53) (−1.89)
Lerner*Crisis −0.0099 0.0246 −0.0355 0.0020*** 0.0121 0.0116 0.0049 −0.0067 −0.0384*** −0.0006* 0.0184*** −0.0381***
(−1.47) (1.55) (−0.61) (2.81) (0.90) (0.39) (1.59) (−0.99) (−3.68) (−1.95) (4.58) (−11.21)
Assets 0.0285 −0.0324 0.0449 −0.0023 −0.0023 −0.3248 −0.0624*** −0.0613 0.2455 0.0412*** −0.0639*** −0.0329
(1.67) (−1.43) (0.84) (−0.08) (−0.03) (−1.22) (−4.48) (−1.20) (−0.77) (14.31) (−8.55) (−0.80)
Assets2 −0.0010 0.0009 −0.0014 −0.0002 −0.0005 0.0120 0.0022*** 0.0019 0.0097 −0.0019*** 0.0013*** 0.0022
(−1.67) (1.27) (−0.74) (−0.13) (−0.17) (1.20) (3.72) (0.87) (0.73) (−13.82) (3.88) (0.72)
Nonperforming Loans Ratios −0.1102 0.1072 −0.0586 −0.2916*** 0.1140* −0.6153*** −0.2971*** 0.0878** −0.3197*** −0.2220*** 0.0510*** −0.1808***
(−1.62) (1.65) (−0.44) (−7.88) (1.83) (−6.17) (−13.05) (2.13) (−9.86) (−155.32) (9.27) (−6.18)
Equity Ratios 0.0588* −0.0942** 0.0770 −0.0270 −0.0162 −0.3724* 0.0027 −0.0356* −0.2388*** 0.0710*** −0.0077 −0.1581***
(1.91) (−2.35) (0.47) (−1.02) (−0.24) (−1.93) (0.18) (−2.04) (−3.75) (17.09) (−0.90) (−3.93)
M&A Activity 0.0031 −0.0037 0.0015 0.0007 0.0002 −0.0099*** −0.0011 −0.0025 −0.0235** 0.0020*** −0.0070** −0.0174***
(0.88) (−0.72) (0.16) (0.51) (0.05) (−3.61) (−0.36) (−0.70) (−2.68) (24.09) (−2.30) (−12.78)
GDP per Capita 0.0278* −0.0944** −0.0770 0.0077 −0.1484* −0.2782* −0.0033 0.0671 0.0580 −0.0101 −0.0112 −0.1581
(1.85) (−2.21) (−1.12) (0.33) (−1.80) (−2.04) (−0.26) (1.70) (0.61) (−0.66) (−0.11) (−0.79)
GDP Growth Rates −0.2527** 0.6932*** −0.4280* −0.1623* 0.7360** −0.8574* 0.0618 0.7311*** −0.4730 0.0142 0.4561* 0.1858
(−2.55) (3.81) (−1.90) (−1.94) (2.22) (−1.80) (0.86) (3.33) (−1.09) (0.10) (1.98) (0.41)
M2 to GDP −0.0036 −0.0271** −0.0165 0.0048* −0.0238 −0.0018 −0.0020 −0.0169 0.0364 0.0165 0.1273 0.2519
CONTEMPORARY ECONOMIC POLICY

(−0.85) (−2.30) (−0.57) (1.72) (−1.54) (−0.05) (−0.36) (−0.52) (0.83) (0.80) (0.88) (1.13)
Constant −0.3838* 1.4322*** 0.8771 0.0667 1.7773* 5.4739** 0.5384*** −0.1509 1.1832 −0.0854 0.6564 1.7716
(−1.76) (3.66) (1.24) (0.21) (1.79) (2.48) (4.12) (−0.29) (1.17) (−0.56) (0.66) (0.86)
Bank fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.0592 0.0334 0.0458 0.1999 0.0687 0.1200 0.2001 0.0784 0.1453 0.0910 0.1087 0.1794
Observations 14,806 14,806 14,806 9,237 9,237 9,237 49,915 49,915 49,915 44,936 44,936 44,936

Notes: This table reports the fixed effects regression estimates of market power on liquidity risk by dividing banks into four groups, depending on total assets, following Cornett et al. (2011). Panels A and B show
the results for large banks (total assets greater than US$1 billion) and medium banks (total assets between US$500 million and US$1 billion), respectively. Panel C consists of Panel C1 (small banks) and Panel C2
(smallest banks); small banks are those with total assets between US$100 million and US$500 million, while smallest banks are those with total assets less than or equal to US$100 million. The dependent variables are
liquidity risks from committed credit lines (Credit Lines), liquid asset holdings (Liquid Assets), and liquidity creation (Liquidity Creation). Assets2 is the squared bank size term. Detailed information on the variables
is provided in Table 1. Robust standard errors are clustered by country. The t-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
 TABLE 6
Instrumental Variables Approach
Panel A: All Banks Panel B: Large Banks Panel C: Small Banks
Credit Liquid Liquidity Credit Liquid Liquidity Credit Liquid Liquidity
Lines Assets Creation Lines Assets Creation Lines Assets Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.1218*** 0.0047 0.4483* 0.0162*** −0.2565*** 0.2682** 0.1049*** −0.0868 0.5168***
(4.45) (0.04) (1.89) (3.20) (−3.28) (2.46) (19.62) (−1.45) (4.96)
Crisis −0.0067 0.0356** −0.0503 −0.0135*** 0.0437*** −0.1166***
(0.67) (2.02) (−0.45) (−28.12) (13.65) (−11.19)
Lerner*Crisis 0.0043 0.1315 0.1708 −0.0375*** 0.0446*** −0.2416***
(0.08) (1.17) (0.49) (−14.50) (2.83) (−5.04)
Assets −0.0059 −0.0536** −0.0183 0.0084 −0.0173 0.0177 0.0428*** −0.0523*** 0.0330
(−0.78) (−1.96) (−0.28) (0.52) (−0.71) (0.32) (18.29) (−5.90) (−1.18)
Assets2 −0.0001 0.0012* −0.0002 −0.0004 0.0008 −0.0001 −0.0024*** 0.0001 −0.0003
(−0.43) (1.75) (−0.10) (−0.63) (1.19) (−0.06) (−21.66) (0.10) (−0.44)
Nonperforming Loans Ratios −0.1140*** 0.1021 0.1133 −0.2519** 0.0768 −0.4477* −0.1335*** 0.2236*** −0.2355**
(−2.92) (0.61) (0.37) (−2.47) (0.72) (−1.74) (−21.60) (5.78) (−2.07)
Equity Ratios 0.0575*** −0.0189 −0.1324* 0.0391 0.0048 0.2162 0.0796*** 0.0141 −0.1396***
(7.24) (−0.80) (−1.66) (1.38) (0.06) (1.53) (26.71) (1.39) (−6.88)
M&A Activity −0.0018 0.0039 −0.0122** 0.0041 −0.0076* 0.0111 0.0030*** −0.0107*** −0.0044
(−0.86) (1.40) (−2.15) (1.28) (−1.95) (1.14) (7.22) (−3.39) (−0.91)
GDP per Capita 0.0295*** −0.0518 0.0928 0.0219*** −0.0020 −0.0047 0.0488*** −0.0072 0.1243
(2.77) (−1.52) (1.14) (2.60) (−0.08) (−0.14) (9.71) (−0.33) (1.28)
GDP Growth Rates −0.0919*** 0.2096 −0.9777*** 0.0103 0.1345 0.2635 −0.0152 0.4310*** −0.9618***
(−3.57) (1.46) (−5.14) (0.23) (1.23) (0.90) (−0.91) (6.24) (−2.77)
M2 to GDP −0.0001 −0.0100 0.0100 −0.0063 −0.0291** −0.0210 −0.0633*** 0.2881*** −0.6028***
(−0.02) (−0.68) (0.25) (−1.50) (−2.57) (−0.78) (−5.80) (6.07) (−2.79)
First-stage
Instrumental variable
Entry Barriers 0.0312*** 0.0312*** 0.0312*** 0.0076 0.0076 0.0076 0.0418*** 0.0418*** 0.0418***
(3.18) (3.18) (3.18) (0.82) (0.82) (0.82) (28.11) (28.11) (28.11)
Control of Corruption −0.0136** −0.0136** −0.0136** −0.0401** −0.0401** −0.0401** −0.0225*** −0.0225*** −0.0225***
(−2.14) (−2.14) (−2.14) (−2.37) (−2.37) (−2.37) (−7.05) (−7.05) (−7.05)
First stage F-test of instruments 16.19 16.19 16.19 13.24 13.24 13.24 104.23 104.23 104.23
p value 0.0000 0.0000 0.0000 0.0056 0.0056 0.0056 0.0000 0.0000 0.0000
Hansen J-test of overidentifying restrictions 1.979 2.047 2.315 1.216 2.510 1.103 0.668 0.944 1.709
p value 0.1595 0.1525 0.1281 0.2701 0.1131 0.5761 0.4137 0.3312 0.1911
Bank fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK

Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.0308 0.0504 0.0188 0.0351 0.0273 0.0141 0.0148 0.0678 0.0264
Observations 118,894 118,894 118,894 14,806 14,806 14,806 44,936 44,936 44,936

Notes: This table reports the results of IV regressions on the relation between market power and liquidity risk. Panels A, B, and C show the second-stage regression results for all banks, large banks (total assets
greater than US$1 billion), and small banks (total assets less than or equal to US$100 million), respectively. The dependent variables of the second-stage regressions are liquidity risks from committed credit lines
(Credit Lines), liquid asset holdings (Liquid Assets), and liquidity creation (Liquidity Creation). Assets2 is the squared bank size term. The lower panel of the table shows the first-stage regression results—the dependent
variable is the Lerner index (Lerner)—for our IV. The first stage F-test and the Hansen’s J-test check for the relevance and the validity of the instruments, respectively. Robust standard errors are clustered by country.
Detailed information on the variables is provided in Table 1. The z-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
13
14 CONTEMPORARY ECONOMIC POLICY
a country as IV. Tighter entry restrictions help
banks increase market power (Cetorelli and Stra-
han 2006; Claessens and Laeven 2004). Control
of Corruption measures the degree to which pub-
lic power is exercised for private gain. Corruption
hinders transparency and effective competition.
Panel A shows that coefficients of Lerner for
Credit Lines and Liquidity Creation are positive
and statistically significant. These results indi-
cate that banks with greater market power take
on more liquidity risk. With respect to IV, Entry
Barriers is positively (0.0312) and significantly
related to Lerner, and therefore, consistent with
the above notion. Control of Corruption is nega-
tively (−0.0136) and significantly associated with
Lerner, implying that a country with better con-
trol of corruption has a more competitive bank-
ing system. To be valid, the IV should satisfy
two conditions. First, they have to be exogenous
to liquidity risk-taking during the sample period.
Second, they have to be correlated with mar-
ket power. We present the results of specification
tests regarding the relevance and the validity of
the IV. The F-statistic and J-statistic show that
our instruments are appropriate.
In Panel B, the coefficients of Lerner in Mod-
els (1)–(3) confirm that large banks take more
liquidity risk as they obtain more market power.
The coefficients of Lerner*Crisis in all models
for large banks are insignificant, suggesting that
large banks with greater market power still take
on more liquidity risk during a crisis. For the IV,
the coefficients of Entry Barriers and Control of
Corruption have the expected signs. The coef-
ficient of Control of Corruption is significantly
negative while that of Entry Barriers is insignifi-
cantly positive.
During normal times, small banks in Panel
C also show the same results as large banks;
competition is beneficial for financial stabil-
ity of small banks. The coefficients of Lerner
for Credit Lines and Liquidity Creation are
positive and statistically significant at the 1%
level while the coefficient of Liquid Assets is
insignificantly negative. During a crisis, how-
ever, small banks decrease their liquidity risk
exposure when they have greater market power.
Lerner*Crisis is significantly negatively related
to Credit Lines and Liquidity Creation while it
is significantly positively associated with Liquid
Assets. These results suggest that competition
is detrimental for the stability of small banks
in turbulent times. The coefficients of Entry
Barriers and Control of Corruption of small
banks also provide results that are consistent
with Panel A. In addition, the F-statistic and
J-statistic of small banks also confirm that our
IV are valid.
B. Tobit Analysis
Table 7 reports the results of panel Tobit
regressions of market power on liquidity risk
from committed credit lines and liquid reserves.
The Tobit estimations also show consistent
results with our previous findings. Specifically,
Panels A, B, and C provide results for all banks,
large banks (total assets greater than US$1 bil-
lion), and small banks (total assets less than or
equal to US$100 million), respectively. Panel A
shows a positive relationship between market
power and liquidity risk. For liquidity risk from
committed credit lines, the coefficient of Lerner
is positive and statistically significant at the 1%
level, suggesting that banks with greater market
power take more liquidity risk by increasing the
exposure to committed credit lines. For liquidity
risk from liquid asset holdings, the coefficient of
Lerner is negative and statistically significant,
implying that banks with greater market power
take more liquidity risk by reducing liquid asset
reserves. Panel B presents that, during a crisis,
large banks with greater market power do not
change their liquidity-risk taking behavior in
terms of liquidity risk from committed credit
lines and from liquid asset holdings. Small
banks in Panel C, however, reduce liquidity risk
as they have more market power during times
of crisis.
C. Dynamic Panel GMM Estimation
Table 8 reports the system GMM estimates
of the dynamic model. Panels A, B, and C pro-
vide results for all banks, large banks (total
assets greater than US$1 billion), and small banks
(total assets less than or equal to US$100 mil-
lion), respectively. In Panel A, the lagged depen-
dent variables (L. Credit Lines, L. Liquid Assets,
and L. Liquidity Creation) are positively and
significantly related to the dependent variables
(Credit Lines, Liquid Assets, and Liquidity Cre-
ation), suggesting that a bank’s liquidity risk-
taking behavior is highly persistent over time.
Consistent with our earlier results, market power
has a positive and significant effect on a bank’s
liquidity risk-taking, even after controlling for
the dynamic nature of the relationship between
competition and liquidity risk. The lower panel
in Table 8 shows test statistics and p values
for the AR (1) and AR (2) tests as well as the
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK 15

TABLE 7
Tobit Analysis
Panel A: All Banks Panel B: Large Banks Panel C: Small Banks
Credit Lines Liquid Assets Credit Lines Liquid Assets Credit Lines Liquid Assets
(1) (2) (1) (2) (1) (2)
Lerner 0.0241*** −0.0608*** 0.0439*** −0.0856*** 0.0129*** −0.0492***
(24.04) (−30.43) (9.27) (−11.07) (8.46) (−14.53)
Crisis −0.0315 0.0578 −0.0052*** 0.0446
(−1.48) (0.20) (−3.61) (1.08)
Lerner*Crisis −0.0134 0.0322 −0.0033** 0.0201***
(−0.85) (1.06) (−2.03) (3.50)
Assets 0.0153*** −0.0694*** 0.0345*** −0.0324** 0.0515*** −0.0672***
(8.90) (−20.76) (4.27) (−2.37) (10.82) (−6.40)
Assets2 −0.0005*** 0.0023*** −0.0011*** 0.0010** −0.0021*** 0.0017***
(−8.09) (17.77) (−4.34) (2.18) (−9.30) (3.43)
Nonperforming Loans Ratios −0.2794*** 0.0116 −0.0560*** 0.0214 −0.2330*** 0.0551***
(−57.17) (1.18) (−2.93) (0.67) (−28.98) (2.97)
Equity Ratios 0.0664*** 0.0152*** 0.0945*** −0.0835*** 0.0898*** 0.0417
(26.87) (3.10) (6.80) (−3.74) (27.00) (0.86)
M&A Activity 0.0004 0.0025 0.0025 −0.0027 0.0027 −0.0091
(0.36) (1.16) (1.09) (−0.71) (0.71) (−1.00)
GDP per Capita 0.0397*** −0.0836*** 0.0454*** −0.0640*** 0.0916*** −0.1220***
(21.35) (−25.82) (11.21) (−9.77) (12.75) (−11.73)
GDP Growth Rates −0.1867*** 0.8465*** −0.2583*** 0.6455*** 0.0141 0.3010
(−8.29) (20.73) (−5.76) (9.11) (0.12) (1.48)
M2 to GDP −0.0245*** 0.0692*** −0.0303*** 0.0347*** −0.1039*** 0.1753***
(−25.24) (40.83) (−16.46) (11.58) (−16.85) (26.08)
Constant −0.4309*** 1.4098*** −0.6293*** 1.0525*** −1.1397*** 1.7734***
(−18.78) (34.17) (−8.34) (8.38) (−14.34) (14.48)
Time dummies Yes Yes Yes Yes Yes Yes
Wald χ2 14,985.00 9,580.79 1,023.82 532.71 4,364.15 6,095.95
p value 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
ρ 0.8177 0.7691 0.8309 0.8266 0.8085 0.6542
Observations 118,894 118,894 14,806 14,806 44,936 44,936

Notes: This table shows the results of the random-effect Tobit regressions regarding liquidity risk from committed credit lines
and liquid asset holdings because those two dependent variables are left-censored at zero. Panels A, B, and C show the results
for all banks, large banks (total assets greater than US$1 billion), and small banks (total assets less than or equal to US$100
million), respectively. Assets2 is the squared bank size term. Detailed information on the variables is provided in Table 1. This
table provides the estimated marginal effects. For dummy variables, the marginal effects are calculated as the discrete change in
the expected value of the dependent variables. Robust standard errors are clustered by country. The z-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.

Sargan test. The AR (1) and AR (2) tests show
high first-order autocorrelation and no significant
second-order autocorrelation. The Sargan test of
over-identifying restrictions does not reject the
null hypothesis that the instruments are valid.
Therefore, the statistics suggest that our specifi-
cations are all appropriate. Panels B and C also
confirm our previous findings; large banks do not
have significant coefficients for Lerner*Crisis,
whereas small banks show a negative relationship
between market power and bank liquidity risk
during a crisis, after controlling for the dynamic
aspect of the relationship between competition
and liquidity risk.
D. Weighted Least Squares Regressions and
Subsample Regressions Excluding Banks in the
United States
We note that most of our observations come
from the United States. To assess whether our
results for the relationship between market power
and bank liquidity risk are driven by the United
States, we re-estimate our models as follows.
First, we conduct weighted least squares (WLS)
regressions to limit the overrepresentation of U.S.
banks. The WLS regression results are presented
in Panel A. We weigh each observation by the
inverse number of bank-year observations per
country. Consistent with our earlier regression
 16
TABLE 8
Dynamic Panel Data Models
Panel A: All Banks Panel B: Large Banks Panel C: Small Banks
Credit Liquid Liquidity Credit Liquid Liquidity Credit Liquid Liquidity
Lines Assets Creation Lines Assets Creation Lines Assets Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
L. Credit Lines 0.6454*** 0.7539*** 0.5573***
(56.66) (24.75) (28.19)
L. Liquid Assets 0.4554*** 0.5422*** 0.4389***
(22.22) (10.06) (17.75)
L. Liquidity Creation 0.7756*** 0.8252*** 0.7371***
(64.45) (26.18) (45.18)
Lerner 0.0057*** −0.0352*** 0.0151* 0.0131** −0.0281* 0.0081* 0.0039** −0.0370*** −0.0002
(2.73) (−6.55) (1.90) (2.54) (−1.91) (1.85) (2.29) (−3.69) (−1.02)
Crisis −0.0212*** 0.0106* −0.0397*** −0.0074* 0.0103 −0.0297
(−7.75) (1.78) (−3.55) (−1.96) (0.82) (−0.92)
Lerner*Crisis −0.0108 −0.0042 −0.0144 −0.0027*** 0.0223* −0.0316***
(−0.87) (−0.28) (−0.48) (−2.63) (1.77) (−3.49)
Assets −0.0071 −0.0487** −0.0450 −0.0030 0.0092 −0.0292 −0.0359 −0.1233 0.2061**
(−0.95) (−1.96) (−1.22) (−0.22) (0.40) (−0.47) (−0.82) (−1.30) (2.68)
Assets2 0.0002 0.0011 0.0022 0.0002 −0.0001 0.0012 −0.0018** 0.0044 −0.0098***
(0.80) (1.08) (1.51) (0.45) (−0.09) (0.56) (−2.01) (0.99) (−3.53)
Nonperforming Loans Ratios −0.0755*** 0.1418*** −0.1788*** −0.0760*** 0.2321*** −0.0906 −0.0633*** 0.1230*** −0.1800***
(−7.96) (6.91) (−5.03) (−2.59) (4.13) (−0.83) (−4.32) (2.91) (−2.98)
Equity Ratios 0.0140 −0.3837*** 0.2802*** 0.0701*** −0.0024 0.4145*** 0.0238 −0.3824*** −0.0458
(0.91) (−8.06) (3.93) (2.70) (−0.02) (3.09) (1.40) (−4.80) (−0.48)
M&A Activity 0.0007 −0.0050 −0.0099 0.0002 −0.0050 −0.0013 0.0133*** 0.0090 0.0086
(0.41) (−1.64) (−1.64) (0.08) (−1.10) (−0.14) (2.62) (0.99) (0.58)
GDP per Capita 0.0071** 0.0099 0.0387*** 0.0214*** −0.0068 0.0261 0.0230*** 0.0792*** 0.1287***
(2.38) (1.41) (4.34) (3.40) (−0.41) (1.05) (3.09) (3.74) (4.64)
GDP Growth Rates 0.1683*** −0.1547*** 0.4121*** −0.0870** 0.0115 −0.1176 0.0873 −1.4873*** 0.0599
(6.60) (−2.65) (4.67) (−2.01) (0.12) (−0.73) (1.47) (−7.16) (0.24)
M2 to GDP −0.0027 0.0145 −0.0070 −0.0092*** 0.0178 0.0169 −0.0585* 0.4691 −0.2704*
(−0.81) (0.92) (−0.59) (−2.71) (1.31) (1.18) (−1.70) (−0.77) (−1.84)
CONTEMPORARY ECONOMIC POLICY

Constant −0.0024 0.4044** −0.1576 −0.1871 −0.0104 −0.0625 −0.0132 0.4497 −2.1728***
(−0.04) (2.32) (−0.65) (−1.52) (−0.04) (−0.12) (−0.11) (0.82) (−2.96)
Time dummies Yes Yes Yes Yes Yes Yes Yes Yes Yes
Observations 105,908 105,908 105,908 12,948 12,948 12,948 38,907 38,907 38,907
Number of banks 10,694 10,694 10,694 2,102 2,102 2,102 5,071 5,071 5,071
Number of instruments 127 127 127 127 127 127 127 127 127
AR(1) (p value) 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
AR(2) (p value) 0.9981 0.2770 0.7540 0.3478 0.0043 0.1019 0.8015 0.1193 0.4040
Sargan test (p value) 0.7545 0.8688 0.7178 0.8244 0.8097 0.5751 0.5958 0.2916 0.4956

Notes: This table shows the results of dynamic panel system GMM regressions. Panels A, B, and C show the results for all banks, large banks (total assets greater than US$1 billion), and small banks (total assets less
than or equal to US$100 million), respectively. The dependent variables are liquidity risks from committed credit lines (Credit Lines), liquid asset holdings (Liquid Assets), and liquidity creation (Liquidity Creation).
Detailed information on the variables is provided in Table 1. Assets2 is the squared bank size term. The number of instruments is fewer than the number of groups. The AR (1) and AR (2) show the Arellano-Bond tests
for first- and second-order autocorrelation in the first-differenced residuals. The Sargan test of over-identifying restrictions examines the validity of IV. Detailed information on the variables is provided in Table 1. The
z-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK
results, we find a positive relationship between
market power and bank liquidity risk. During a
crisis, large banks with greater market power still
take higher liquidity risk while small banks with
more market power decrease their liquidity risk-
taking. Second, we remove U.S. bank observa-
tions from the sample in Panel B. Our findings
are robust to the exclusion of U.S. banks’ obser-
vations (Table 9).
E. Alternative Measure of Competition: Boone
Indicator
The Boone indicator, defined as the elasticity
of profits to marginal costs, was recently added
to the literature. The indicator captures competi-
tion via the reallocation of profits from inefficient
banks to the efficient ones. Specifically, competi-
tion enhances performance of efficient banks with
lower marginal costs. The Boone indicator should
be negative, given that profits and marginal cost
have a negative relationship. Hence, higher val-
ues of the Boone indicator represent a less com-
petitive industry.
We construct the Boone indicator following
Schaeck and Cihák (2014) by using marginal
costs calculated from Equation (3), instead of
using average costs. It ranges from −0.1280 to
0.0384, with a mean of −0.0552 and a standard
deviation of 0.0222. Table 10 shows the results
for the Boone indicator. Panel A provides the
results for all banks. The coefficients of Credit
Lines and Liquidity Creation are significantly
positive, while the coefficient of Liquid Assets is
significantly negative. These results suggest that
an increase in a bank’s market power—through
the reallocation of profits from inefficient banks
to efficient ones—leads the bank to take on more
liquidity risk. Panels B and C report the results
for large and small banks, respectively. During
a crisis, large banks with more market power
do not change their liquidity risk-taking behav-
ior. However, small banks with greater market
power, which may be attributed to efficient busi-
ness strategies, pursue more sound liquidity risk
policies in turbulent times.
F. Market Liquidity Risk
Funding liquidity is closely related to mar-
ket liquidity (Brunnermeier and Pedersen 2009).
When market liquidity dries up, banks often
face difficulties to sell assets without significant
losses. Therefore, funding liquidity risk and mar-
ket liquidity risk should be considered simultane-
ously (Soula 2015). We included the magnitude
17
of money supply (M2) to control for market liq-
uidity in our previous regressions (Equations (4)
and (5)).
Table 11 repeats the previous tests adding the
risk premium on lending (Panel A) and the real
interest rates (Panel B) to account for the effect
of market liquidity risk. The information on the
risk premium on lending and the real interest
rates is obtained from the WDI. Risk Premium
on Lending is defined as the interest rate charged
by banks on loans to private sector customers
minus the “risk free” treasury bill interest rate.
It has 112,750 observations because there are
missing values for some countries. It ranges from
−0.0005 to 0.0892, with a mean of 0.0318 and a
standard deviation of 0.0049. Real Interest Rates
is defined as the lending interest rate adjusted
for inflation, as measured by the GDP deflator. It
ranges from −0.0563 to 0.1473, with a mean of
0.0302 and a standard deviation of 0.0170. Our
findings remain unchanged even after controlling
for the effect of market liquidity risk.
Moreover, we conduct several robustness tests
as follows. First, we replace bank fixed effects
with country fixed effects. In this case, standard
errors are clustered at the bank level to control
for heteroskedasticity and serial correlation. The
results are reported in Table 12.
Second, a higher level of credit line commit-
ment and liquidity creation may not necessar-
ily imply higher liquidity risk if sufficient fund-
ing sources support liquidity production. There-
fore, as shown in Table 13, we introduce the
short-term money market funding ratio (Short-
term Funding) as a funding side variable in the
control variable set. Third, we re-estimate our
models for bank size (shown in Table 5) by using
only the linear term (Assets), instead of using
both the linear term (Assets) and the squared
term (Assets2 ) in Equation (5). Finally, to check
whether our results are driven by outliers, we
repeat our tests by excluding largest banks (total
assets > US$100 billion or total assets > US$50
billion) from the sample. Our results continue to
hold in all cases.
VII. CONCLUSION
There is a rich body of research on the rela-
tionship between bank competition and financial
stability from the perspective of credit risk or
default risk. However, in spite of the importance
of liquidity risk, a few studies have done from this
perspective. Does the magnitude of competition
affect banks’ liquidity risk-taking behavior? Does
 18

TABLE 9
Weighted Least Squares Regressions and Subsample Regressions Excluding U.S. Banks
Panel A: WLS Regressions
Panel A1: All Banks Panel A2: Large Banks Panel A3: Small Banks
Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.0148*** −0.0364** 0.0971*** 0.0171** −0.0217* 0.0939** 0.0010** −0.1048*** 0.1037*
(3.89) (−2.15) (3.20) (2.40) (−1.77) (2.31) (2.15) (−2.82) (1.93)
Crisis 0.0207 0.1224*** −0.0363* −0.0275** 0.0693 −0.0094
(1.45) (3.69) (−1.98) (−2.35) (0.96) (−0.09)
Lerner*Crisis −0.0107 −0.0092 −0.1315 −0.0156** 0.0024* −0.0781**
(−0.46) (−0.19) (−1.58) (−2.14) (1.92) (−2.52)
Assets 0.0214*** −0.0406** 0.1820*** 0.0236** −0.1217*** −0.0281 0.0199 −0.0131 0.4394**
(3.85) (−2.56) (6.42) (2.16) (−3.34) (−0.42) (0.87) (−0.12) (2.04)
Assets2 −0.0004** 0.0009* −0.0072*** −0.0005 0.0036*** −0.0005 −0.0003 0.0027 −0.0172*
(−2.27) (1.82) (−7.44) (−0.80) (3.14) (−0.25) (−0.22) (0.54) (−1.90)
Nonperforming Loans Ratios 0.0270 −0.4122*** −0.0849 0.0310 −0.3553*** −0.2181* −0.0097 0.1146 0.8751**
(1.20) (−6.17) (−0.76) (1.02) (−4.52) (−1.78) (−0.10) (0.41) (2.10)
Equity Ratios 0.0481*** 0.0488 −0.5170*** 0.0609*** −0.1716*** −0.4939*** −0.0085 0.2491*** −0.6508***
(5.19) (1.59) (−9.71) (2.87) (−3.00) (−5.52) (−1.00) (4.04) (−7.59)
M&A Activity 0.0070 −0.0133* −0.0483*** 0.0052 −0.0168** −0.0522*** −0.0324*** −0.1224** −0.4204***
(1.49) (−1.85) (−3.15) (1.04) (−2.30) (−3.14) (−2.83) (−2.55) (−3.99)
GDP per Capita 0.0135 −0.2161*** −0.1421*** 0.0114 −0.1751*** −0.0624 0.0286** 0.2374*** −0.0984
(1.61) (−10.11) (−3.93) (1.00) (−6.29) (−1.43) (2.39) (2.86) (−0.84)
GDP Growth Rates 0.1733** 0.7398*** −0.4929 0.1607 0.7014*** −0.7758** −0.0354 0.5034 0.3426
CONTEMPORARY ECONOMIC POLICY

(2.28) (4.05) (−1.51) (1.62) (3.34) (−2.17) (−0.25) (0.62) (0.31)

M2 to GDP −0.0094*** 0.0090 0.0260* −0.0128*** 0.0107 0.0321* 0.0100 −0.2245*** −0.1580*
(−2.79) (0.84) (1.70) (−2.88) (0.91) (1.72) (1.04) (−3.21) (−1.65)
Constant −0.3442*** 2.8275*** 1.0379** −0.3480* 3.0806*** 1.8771*** −0.4730*** −2.0956** −0.7545
(−3.61) (11.74) (2.49) (−1.68) (7.76) (2.71) (−3.75) (−2.30) (−0.47)
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.2445 0.2553 0.2822 0.2492 0.2608 0.2556 0.2712 0.3868 0.3920
Observations 118,894 118,894 118,894 14,806 14,806 14,806 44,936 44,936 44,936
 TABLE 9
Continued
Panel B: FE Regressions excluding U.S. Banks
Panel B1: All Banks Panel B2: Large Banks Panel B3: Small Banks
Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.0076* −0.0502** 0.0451** 0.0092*** −0.0618** 0.0374*** 0.0701* −0.0231** 0.0832***
(1.98) (−2.23) (2.61) (3.10) (−2.11) (3.89) (1.90) (2.64) (3.06)
Crisis −0.0153 0.0693** −0.1174** 0.0100 0.5372 −0.6431*
(−0.83) (2.54) (−2.13) (0.54) (0.43) (−1.85)
Lerner*Crisis −0.0093 0.0278 0.0515 −0.0139* 0.1053*** −0.0553**
(−0.92) (1.00) (1.13) (−2.04) (2.97) (−2.35)
Assets 0.0280* −0.0326** 0.2110 0.0377* −0.0134 0.0610 0.0122 −0.0821 0.1403**
(1.74) (−2.36) (0.70) (1.83) (−0.33) (0.69) (0.48) (−0.50) (2.41)
Assets2 −0.0010* 0.0013* −0.0078 −0.0013* 0.0004 −0.0028 −0.0002** 0.0047 −0.0046
(−1.75) (1.92) (−0.58) (−1.75) (0.29) (−0.91) (−2.14) (0.57) (−0.30)
Nonperforming Loans Ratios 0.0027 0.1299 −0.1212 0.0068 0.0901 0.1667 −0.0656* 0.2219 −1.5615*
(0.09) (1.17) (−0.72) (0.16) (0.88) (0.94) (−1.88) (1.48) (−2.02)
Equity Ratios 0.0243** 0.0221 −0.4329*** 0.0982*** −0.0757 −0.2407 0.0267** 0.0156 −0.6778**
(2.54) (0.49) (−4.32) (2.86) (−1.00) (−1.70) (2.10) (0.13) (−2.40)
M&A Activity 0.0041 −0.0027 0.0052 0.0073 −0.0100 −0.0083 0.0023 −0.2108** −0.0603
(0.76) (−0.27) (0.26) (1.39) (−1.37) (−0.58) (0.13) (−2.72) (−0.71)
GDP per Capita 0.0245 −0.0582 0.0681 0.0263 −0.0966 0.0593 0.0013 −0.6490*** −0.8817
(1.22) (−0.65) (0.65) (1.09) (−1.59) (0.90) (0.05) (−3.04) (−1.63)
GDP Growth Rates −0.0585 0.6062*** −0.3896 −0.0896 0.4867*** −0.4841* 0.3099* 0.4764 −0.2719
(−0.84) (3.32) (−1.19) (−1.13) (3.05) (−1.80) (2.08) (0.99) (−0.24)
M2 to GDP −0.0039 −0.0199 0.0003 −0.0027 −0.0296** −0.0226 0.0198 −0.0061 0.0063
(−1.49) (−1.12) (0.01) (−1.10) (−2.44) (−0.70) (1.12) (−0.04) (0.03)
Constant −0.3917 0.6799 −1.4034 −0.4810 1.3974** −0.1824 −0.1517 7.1445*** 8.5298
(−1.44) (0.69) (−1.27) (−1.59) (2.36) (−0.23) (−0.54) (2.94) (1.32)
Bank fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK

R2 0.0175 0.0189 0.0436 0.0288 0.0327 0.0470 0.0404 0.1098 0.2064

Observations 12,797 12,797 12,797 7,553 7,553 7,553 720 720 720

Notes: This table shows the results to mitigate the concern for overrepresentation of U.S. banks. Panel A reports the results of the WLS regressions. Panels A1, A2, and A3 show the
results for all banks, large banks (total assets greater than US$1 billion), and small banks (total assets less than or equal to US$100 million), respectively. Each observation is weighted by
the inverse number of bank-year observations in the corresponding country. Panel B presents the FE regression results for banks in all sample countries, excluding the US. Panels B1, B2,
and B3 show the results for all banks, large banks, and small banks, respectively. The dependent variables are liquidity risks from committed credit lines (Credit Lines), liquid asset holdings
(Liquid Assets), and liquidity creation (Liquidity Creation). Detailed information on the variables is provided in Table 1. Robust standard errors are clustered by country. The t-statistics are
in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
19
 20

TABLE 10
Alternative Measure of Competition: Boone Indicator
Panel A: All Banks Panel B: Large Banks Panel C: Small Banks
Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Boone 0.0232** −0.0662* 0.1943*** 0.0853*** −0.0385 0.1777* 0.1235** −0.4161** 0.1249***
(2.08) (−1.93) (4.99) (2.83) (−1.50) (2.03) (2.32) (−2.15) (3.24)
Crisis −0.0136* 0.0877*** 0.0767 −0.0278** 0.0671 0.0724
(−1.72) (3.88) (1.53) (−2.33) (1.08) (0.70)
Boone*Crisis 0.0508 0.2586 0.1226 −0.0391** 0.3236* −0.0871**
(1.63) (1.39) (0.83) (−2.52) (1.99) (−2.23)
Assets 0.0155*** −0.0727*** 0.0119 0.0283* −0.0288 0.0457 0.0389*** −0.0600*** −0.0383
(2.99) (−6.63) (0.36) (1.91) (−1.28) (0.87) (17.09) (−7.47) (−1.23)
Assets2 −0.0006*** 0.0019*** −0.0001 −0.0010 0.0007 −0.0014 −0.0016*** 0.0008** 0.0028*
(−2.92) (4.86) (−0.09) (−1.53) (1.01) (−0.72) (−15.30) (2.19) (1.88)
Nonperforming Loans Ratios −0.3101*** 0.1161*** −0.3842*** −0.1308 0.1529** −0.0763 −0.2483*** 0.1140*** −0.2617***
(−6.01) (6.76) (−11.26) (−1.58) (2.28) (−0.54) (−80.28) (28.91) (−9.07)
Equity Ratios 0.0529*** −0.0209** −0.1424*** 0.0663** −0.1104*** 0.0958 0.0672*** 0.0015 −0.1712***
(8.55) (−2.71) (−2.92) (2.16) (−2.83) (0.56) (22.88) (0.17) (−4.32)
M&A Activity 0.0004 0.0025 −0.0167** 0.0038 −0.0051 0.0019 0.0018*** −0.0067* −0.0176***
(0.19) (0.99) (−2.72) (1.06) (−0.96) (0.20) (19.14) (−2.07) (−17.16)
GDP per Capita 0.0170 −0.0476 −0.0315 0.0309* −0.1067** −0.0667 −0.0176 −0.0135 −0.1673
(1.62) (−0.99) (−0.38) (2.05) (−2.58) (−0.97) (−1.03) (−0.13) (−0.85)
GDP Growth Rates −0.1943*** 0.8477*** −0.5933*** −0.2418** 0.6766*** −0.4048 0.0745 0.5753* 0.2422
(−2.93) (4.78) (−3.25) (−2.55) (3.69) (−1.71) (0.56) (1.75) (0.43)
M2 to GDP −0.0026 −0.0118 −0.0023 −0.0035 −0.0267** −0.0160 0.0160 0.1316 0.2604
(−0.64) (−0.79) (−0.05) (−0.85) (−2.31) (−0.55) (0.69) (0.87) (1.21)
CONTEMPORARY ECONOMIC POLICY

Constant −0.1921 1.1818** 0.4813 −0.4220* 1.5389*** 0.7459 −0.0165 0.6432 1.8662
(−1.58) (2.34) (0.53) (−1.94) (4.02) (1.06) (−0.10) (0.62) (0.93)
Bank fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.1158 0.0634 0.1125 0.0545 0.0288 0.0445 0.0862 0.1039 0.1763
Observations 118,894 118,894 118,894 14,806 14,806 14,806 44,936 44,936 44,936

Notes: This table shows fixed effects regression estimates, employing the Boone indicator as an alternative measure of competition. Panels A, B, and C show the results for all banks, large
banks (total assets greater than US$1 billion), and small banks (total assets less than or equal to US$100 million), respectively. The dependent variables are liquidity risks from committed
credit lines (Credit Lines), liquid asset holdings (Liquid Assets), and liquidity creation (Liquidity Creation). Detailed information on the variables is provided in Table 1. Robust standard
errors are clustered by country. The t-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
 TABLE 11
Market Liquidity Risk
Panel A: Risk Premium on Lending
Panel A1: All Banks Panel A2: Large Banks Panel A3: Small Banks
Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.0273*** −0.0603*** 0.0753*** 0.0435*** −0.1023*** 0.1017*** 0.0213*** −0.0556*** 0.0726***
(33.65) (−17.85) (9.56) (5.26) (−6.75) (3.39) (30.13) (−71.01) (18.41)
Crisis 0.0010 0.0489* 0.0601 −0.0109** 0.0447 0.1350
(0.03) (1.96) (1.07) (−2.17) (1.62) (1.39)
Lerner*Crisis −0.0161 0.0513 −0.0867 −0.0010* 0.0192*** −0.0413***
(−0.96) (1.58) (−1.62) (−1.81) (6.83) (−12.02)
Assets 0.0123** −0.0656*** −0.0239 0.0123 −0.0289 0.0147 0.0427*** −0.0688*** −0.0400
(2.41) (−10.69) (−0.97) (0.52) (−1.00) (0.18) (34.86) (−8.56) (−1.13)
Assets2 −0.0006** 0.0017*** 0.0011 −0.0004 0.0008 0.0000 −0.0019*** 0.0015*** 0.0025
(−2.76) (7.11) (1.14) (−0.52) (0.94) (0.02) (−29.77) (4.38) (1.15)
Nonperforming Loans Ratios −0.3012*** 0.0343** −0.2882*** −0.1636** 0.0912* 0.0510 −0.2223*** 0.0470*** −0.2029***
(−11.75) (2.64) (−11.73) (−2.84) (2.04) (0.39) (−509.73) (16.03) (−18.19)
Equity Ratios 0.0607*** −0.0360*** −0.1063*** 0.0446 −0.1017* 0.3330*** 0.0739*** −0.0139 −0.1495***
(15.32) (−4.59) (−3.85) (1.26) (−1.90) (8.71) (66.35) (−1.41) (−4.80)
M&A Activity 0.0030 0.0031 −0.0126 0.0050 0.0002 0.0062 0.0020*** −0.0047*** −0.0167***
(1.52) (1.46) (−1.65) (1.34) (0.04) (0.68) (81.45) (−51.52) (−93.09)
GDP per Capita −0.0061 −0.0342 0.0126 −0.0012 −0.0993* −0.0727 0.0050 −0.1032 −0.1499
(−0.57) (−0.57) (0.15) (−0.07) (−2.02) (−0.93) (0.38) (−0.83) (−0.43)
GDP Growth Rates −0.0519 0.5960** −0.1256 −0.0971 0.3405 −0.4585 0.0389 1.2266** 1.1965
(−0.50) (2.14) (−0.26) (−0.71) (1.26) (−0.77) (0.40) (2.51) (0.89)
M2 to GDP 0.0215** −0.0185 0.1900* 0.0262** −0.0752 0.0884 −0.0008 0.2837 0.4639
(2.37) (−0.24) (2.07) (2.25) (−0.95) (1.30) (−0.04) (1.10) (1.37)
Risk Premium on Lending 0.0915 −0.1087 0.2819 0.1073 −0.3060 0.4174 0.4453** 1.1177 0.6510
(0.60) (−0.19) (0.31) (0.41) (−0.61) (0.49) (2.49) (0.98) (0.40)
KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK

Constant 0.0530 0.9982 0.0767 0.0064 1.4897*** 0.7558 −0.2566* 1.4773 1.5132
(0.48) (1.60) (0.09) (0.02) (3.44) (0.87) (−2.07) (1.25) (0.45)
Bank fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.1411 0.0871 0.1303 0.1011 0.0548 0.0672 0.0923 0.1123 0.1822
Observations 112,750 112,750 112,750 11,042 11,042 11,042 44,625 44,625 44,625
21
 22
TABLE 11
Continued
Panel B: Real Interest Rates
Panel B1: All Banks Panel B2: Large Banks Panel B3: Small Banks
Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.0273*** −0.0599*** 0.0751*** 0.0410*** −0.0991*** 0.0976*** 0.0213*** −0.0559*** 0.0722***
(32.54) (−16.96) (9.54) (4.33) (−6.28) (3.11) (29.29) (−82.42) (16.66)
Crisis −0.0030 0.0305** −0.1156 −0.0158** −0.0036 0.0552
(−0.33) (2.20) (−0.95) (−2.54) (−0.09) (0.55)
Lerner*Crisis −0.0129 0.0543 −0.0800 −0.0009* 0.0196*** −0.0410***
(−1.34) (1.56) (−0.45) (−1.88) (8.25) (−13.99)
Assets 0.0132** −0.0607*** −0.0199 0.0226 −0.0162 0.0240 0.0427*** −0.0686*** −0.0395
(2.64) (−6.46) (−0.74) (0.87) (−0.50) (0.31) (33.96) (−8.86) (−1.18)
Assets2 −0.0006*** 0.0015*** 0.0010 −0.0008 0.0003 −0.0004 −0.0019*** 0.0015*** 0.0025
(−3.01) (4.00) (0.88) (−0.88) (0.31) (−0.14) (−29.25) (4.47) (1.22)
Nonperforming Loans Ratios −0.2984*** 0.0377** −0.2949*** −0.1638** 0.1264* −0.0497 −0.2223*** 0.0471*** −0.2027***
(−10.78) (2.64) (−11.77) (−2.83) (2.08) (−0.37) (−442.98) (17.47) (−18.58)
Equity Ratios 0.0610*** −0.0332*** −0.1060*** 0.0453 −0.1012* 0.3143*** 0.0738*** −0.0136 −0.1489***
(15.24) (−4.53) (−3.70) (1.32) (−1.92) (7.20) (63.49) (−1.45) (−4.92)
M&A Activity 0.0024 0.0018 −0.0136* 0.0048 −0.0016 0.0067 0.0020*** −0.0047*** −0.0167***
(1.17) (0.73) (−1.96) (1.19) (−0.36) (0.73) (83.52) (−50.75) (−90.98)
GDP per Capita 0.0084 −0.0482 −0.0278 0.0154 −0.0981* −0.1158 0.0054 −0.0675 −0.0957
(0.66) (−0.76) (−0.34) (0.88) (−2.04) (−1.69) (0.42) (−0.52) (−0.30)
GDP Growth Rates −0.0227 0.4591* −0.1599 −0.0668 0.2078 −0.3921 −0.0179 0.6404 0.5204
(−0.19) (1.75) (−0.39) (−0.50) (1.15) (−0.91) (−0.19) (1.71) (0.47)
M2 to GDP 0.0193 −0.0179 0.1565* 0.0288** −0.0610 0.0652 −0.0001 0.2840 0.4631
(1.61) (−0.25) (2.05) (2.17) (−0.88) (1.03) (−0.01) (1.23) (1.48)
Real Interest Rates 0.0093 −0.0934 0.6741 0.0344 −0.3094 0.9697** 0.1711* −0.4259 −0.9959
CONTEMPORARY ECONOMIC POLICY

(0.15) (−0.46) (1.33) (0.46) (−1.31) (2.81) (1.99) (−0.67) (−0.94)

Constant −0.1010 1.1252 0.4661 −0.2414 1.4028*** 1.1301 −0.2549* 1.1927 1.0605
(−0.73) (1.70) (0.55) (−0.82) (3.24) (1.42) (−2.07) (0.96) (0.33)
Bank fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.1391 0.0864 0.1282 0.0940 0.0561 0.0659 0.0924 0.1122 0.1822
Observations 113,489 113,489 113,489 11,520 11,520 11,520 44,650 44,650 44,650

Notes: This table shows fixed effects regression estimates, adding the risk premium on lending (Panel A) and the real interest rates (Panel B) as proxies for market liquidity risk in the
regressions. Panels A1 (B1), A2 (B2), and A3 (B3) provide the results for all banks, large banks (total assets greater than US$1 billion), and small banks (total assets less than or equal to
US$100 million), respectively. The dependent variables are liquidity risk from committed credit lines (Credit Lines), liquid asset holdings (Liquid Assets), and liquidity creation (Liquidity
Creation). Assets2 is the squared bank size term. Detailed information on the variables is provided in Table 1. Risk Premium on Lending is defined as lending rates minus the treasury bill
rates. Real Interest Rates is defined as the lending interest rate adjusted for inflation, as measured by the GDP deflator. Robust standard errors are clustered by country. The t-statistics are in
parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
 TABLE 12
Country Fixed Effects
Panel A: All Banks Panel B: Large Banks Panel C: Small Banks
Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation Credit Lines Liquid Assets Liquidity Creation
(1) (2) (3) (1) (2) (3) (1) (2) (3)
Lerner 0.0206*** −0.0554*** 0.0563*** 0.0343*** −0.0748*** 0.0799*** 0.0117*** −0.0508*** 0.0407***
(12.17) (−12.31) (7.43) (6.04) (−5.26) (3.18) (4.69) (−7.18) (3.62)
Crisis −0.0338*** 0.0857*** 0.0088 0.0071 0.0418 0.0664
(−4.76) (5.86) (0.32) (0.74) (1.13) (1.05)
Lerner*Crisis −0.0074 0.0260 −0.0452 −0.0040** 0.0176** −0.0350***
(−1.12) (1.49) (−1.21) (−2.26) (2.17) (−2.87)
Assets 0.0107*** −0.0709*** 0.0308* 0.0240* −0.0326 0.0566 0.0475*** −0.0760** −0.0211
(2.66) (−7.46) (1.79) (1.72) (−1.53) (1.29) (4.44) (−2.01) (−0.45)
Assets2 −0.0002 0.0021*** −0.0009 −0.0006 0.0010 −0.0021 −0.0019*** 0.0020 0.0017
(−1.26) (5.68) (−1.40) (−1.32) (1.41) (−1.46) (−3.78) (1.15) (0.79)
Nonperforming Loans Ratios −0.2791*** 0.0323* −0.2902*** −0.1056*** 0.0668 −0.0841 −0.2284*** 0.0501 −0.1692***
(−29.73) (1.66) (−8.34) (−3.36) (1.19) (−0.81) (−17.90) (1.60) (−3.11)
Equity Ratios 0.0761*** −0.0091 −0.1174*** 0.0897*** −0.0825* 0.0444 0.0908*** 0.0170 −0.1220***
(13.93) (−0.71) (−4.60) (3.42) (−1.86) (0.36) (14.06) (0.93) (−4.44)
M&A Activity 0.0003 0.0022 −0.0180*** 0.0022 −0.0046 −0.0020 0.0019 −0.0085 −0.0148
(0.19) (0.79) (−3.00) (0.76) (−1.02) (−0.21) (0.39) (−1.22) (−0.91)
GDP per Capita 0.0102* −0.0569*** −0.0345 0.0265** −0.0950*** 0.0744 −0.0222 0.1026 −0.1873
(1.70) (−3.48) (−1.30) (2.57) (−4.33) (1.01) (−1.54) (1.10) (−1.15)
GDP Growth Rates −0.1928*** 0.8909*** −0.6278*** −0.2534*** 0.6853*** −0.4459** 0.0084 0.6069 0.2725
(−5.65) (9.52) (−4.19) (−5.49) (6.19) (−2.29) (0.07) (1.61) (0.46)
M2 to GDP −0.0036 −0.0101 0.0012 −0.0048 −0.0239* −0.0099 0.0198 0.0169 0.1781
(−1.12) (−0.94) (0.07) (−1.11) (−1.84) (−0.50) (1.16) (0.18) (1.06)
Constant −0.2105*** 1.4293*** 0.7468** −0.4777*** 1.5648*** 1.0284** −0.1182 −0.2945 2.1456
(−3.00) (7.90) (2.48) (−3.06) (5.93) (2.06) (−0.83) (−0.33) (1.32)
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.1158 0.0693 0.1148 0.0552 0.0332 0.0452 0.0890 0.1078 0.1783
KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK

Observations 118,894 118,894 118,894 14,806 14,806 14,806 44,936 44,936 44,936

Notes: This table shows fixed effects regression estimates of market power on liquidity risk, using country fixed effects. Panels A, B, and C provides the results for all banks, large banks
(total assets greater than US$1 billion), and small banks (total assets less than or equal to US$100 million), respectively. The dependent variables are liquidity risk from committed credit
lines (Credit Lines), liquid asset holdings (Liquid Assets), and liquidity creation (Liquidity Creation). Assets2 is the squared bank size term. Detailed information on the variables is provided
in Table 1. Robust standard errors are clustered at the bank level. The t-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
23
24 CONTEMPORARY ECONOMIC POLICY

TABLE 13
Funding Structure
Panel A: All Banks Panel B: Large Banks Panel C: Small Banks
Credit Liquidity Credit Liquidity Credit Liquidity
Lines Creation Lines Creation Lines Creation
(1) (2) (1) (2) (1) (2)
Lerner 0.0262*** 0.0680*** 0.0345*** 0.0663* 0.0210*** 0.0735***
(15.09) (5.28) (3.22) (1.80) (23.71) (16.83)
Crisis 0.0143 0.0838 −0.0112** −0.1289*
(1.04) (1.46) (−2.21) (−2.00)
Lerner*Crisis −0.0100 −0.0327 −0.0006* −0.0381***
(−1.51) (−0.54) (−1.78) (−11.18)
Short-term Funding 0.0084 0.1254 −0.0040 0.1680*** 0.0212*** 0.0084
(0.93) (1.56) (−0.46) (3.09) (6.78) (0.18)
Assets 0.0102** 0.0008 0.0284 0.0471 0.0410*** −0.0330
(2.09) (0.02) (1.68) (0.86) (13.99) (−0.76)
Assets2 −0.0005** 0.0001 −0.0010 −0.0016 −0.0018*** 0.0022
(−2.42) (0.04) (−1.68) (−0.80) (−13.54) (0.69)
Nonperforming Loans Ratios −0.2751*** −0.2892*** −0.1105 −0.0460 −0.2209*** −0.1803***
(−6.19) (−9.19) (−1.63) (−0.34) (−146.48) (−6.06)
Equity Ratios 0.0565*** −0.1277** 0.0583* 0.1016 0.0711*** −0.1581***
(7.07) (−2.63) (1.93) (0.64) (17.46) (−3.94)
M&A Activity 0.0001 −0.0163** 0.0030 0.0025 0.0018*** −0.0175***
(0.04) (−2.67) (0.88) (0.28) (23.48) (−9.79)
GDP per Capita 0.0189* −0.0174 0.0276* −0.0688 −0.0051 −0.1561
(1.77) (−0.20) (1.82) (−0.96) (−0.34) (−0.80)
GDP Growth Rates −0.1997*** −0.6285*** −0.2539** −0.3810* 0.0109 0.1845
(−3.31) (−3.27) (−2.60) (−1.81) (0.08) (0.40)
M2 to GDP −0.0022 −0.0037 −0.0035 −0.0189 0.0157 0.2515
(−0.56) (−0.08) (−0.82) (−0.67) (0.74) (1.13)
Constant −0.1713 0.4344 −0.3812* 0.7653 −0.1355 1.7517
(−1.39) (0.44) (−1.76) (1.03) (−0.91) (0.86)
Bank fixed effects Yes Yes Yes Yes Yes Yes
Time fixed effects Yes Yes Yes Yes Yes Yes
R2 0.1218 0.1172 0.0592 0.0522 0.0914 0.1794
Observations 118,894 118,894 14,806 14,806 44,936 44,936

Notes: This table shows fixed effects regression estimates of market power on liquidity risk, controlling for the funding
structure. Panels A, B, and C provide the results for all banks, large banks (total assets greater than US$1 billion), and small
banks (total assets less than or equal to US$100 million), respectively. The dependent variables are liquidity risk from committed
credit lines (Credit Lines) and liquidity creation (Liquidity Creation). Short-term Funding is the ratio of short-term wholesale
funding to total assets. Assets2 is the squared bank size term. Detailed information on the variables is provided in Table 1. Robust
standard errors are clustered by country. The t-statistics are in parentheses.
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.

the impact of competition on liquidity risk change
during the crisis? Is there a difference between
large and small banks in changing their liquidity
risk-taking incentives depending on the degree of
competition during the crisis? We seek answers
to these three questions and contribute to the lit-
erature on competition, liquidity risk, and finan-
cial stability.
Using commercial bank data from 25 OECD
countries during the period 2000–2010, we find
evidence that banks take on more liquidity risk
as they achieve greater market power. This result
implies that competition is beneficial to finan-
cial stability. This result is robust after controlling
for endogeneity concerns, and is robust across
different econometric specifications. During the
crisis, however, the effects of bank market power
on liquidity risk vary across bank size. When
the economy tightens, large banks do not change
their liquidity risk-taking behavior as they obtain
more market power. Instead, large banks with
greater market power increase the exposure to
committed credit lines during the financial cri-
sis of 2008. This implies that large banks with
greater market power take more liquidity risk,
due to the fact that they are more likely to be
bailed out during times of financial turbulence. In
contrast, small banks with greater market power
reduce liquidity risk-taking during the crisis by
holding more liquid assets and by creating less
 KIM: THE EFFECT OF COMPETITION ON BANK LIQUIDITY RISK
liquidity. These results suggest that increased
charter value from enhanced market power con-
tributes to small banks’ financial stability dur-
ing the crisis. To put it differently, if competi-
tion becomes more severe, small banks, which are
less likely to be bailed out, are subject to higher
risk-shifting incentives to survive when the econ-
omy tightens.
While this paper is the first to empirically
investigate the relationship between competition
and stability in terms of bank liquidity risk, it
has some limitations which are worth including
in future work. First, as mentioned above, our liq-
uidity risk measures are incomplete because there
are no concrete liquidity risk measures at present.
Therefore, it would be interesting to investigate
the effect of competition on liquidity risk by
using more rigorous liquidity risk measures in
the future. Second, this study does not consider
the potential interactions between liquidity risk
and other bank risks, such as credit risk or over-
all bank risks. Exploring such interactions would
be an important extension for future work.
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