Research in International Business and Finance: Moau Yong Toh, Dekui Jia

Research in International Business and Finance 56 (2021) 101350
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Research in International Business and Finance

journal homepage: www.elsevier.com/locate/ribaf
Do foreign ownership and home-host country distance matter?

Evidence on the impact of bank market power on liquidity
creation in a selected Southeast Asian country
Moau Yong Toh a, *, Dekui Jia b
a
School of Economics and Management, Xiamen University Malaysia, Jalan Sunsuria, Bandar Sunsuria, 43900 Sepang, Selangor Darul Ehsan,
Malaysia
b
Department of Finance, School of Economics, Changzhou University, 21 Gehu Middle Road, Wujin, 213164 Changzhou, Jiangsu, China
A R T I C L E I N F O A B S T R A C T
JEL classification: This paper examines the roles of foreign ownership and home-host country distance in the impact
G21 of bank market power on bank liquidity creation in a selected Southeast Asian country (Malaysia)
G28 over the period 2001− 2017. A key finding is that the impact of market power on liquidity cre
F21
ation is either significantly negative or insignificant for domestic banks, but is significantly
F23
positive for foreign banks, irrespective of the liquidity creation measures used. This finding points
Keywords:
to evidence of “home-field advantage” of domestic banks as the banks possess greater ability to
Liquidity creation
withstand interest margin compression, while competing with foreign banks in liquidity creation
Market power
Ownership market. Moreover, this paper finds that foreign banks originated from countries with cultural,
Cultural distance economic and institutional distance to the host country require greater market power to boost
Economic distance their liquidity creation performance, as compared to their domestic counterparts. Further analysis
Institutional distance also indicates that the influence of host-home country distance is more evident among small
foreign banks which have lower franchise value. Overall, the findings of this paper suggest that
although bank competition policies may promote customer welfare, foreign banks should be
granted with some degree of market power in the host country to help alleviating the banks’
operational challenges arising from home-host country distance.
1. Introduction
Since the creation of WTO in 1995, banks in developing Southeast Asian countries have experienced increasingly competitive
pressure arising from financial liberalization, deregulation and foreign bank penetration. Malaysia, among other emerging and
developing Southeast Asian countries, has undergone multiple phases of far-reaching regulatory and structural reforms in its banking
sector following a swift recovery from the 1997 Asian financial crisis1 . The reform initiatives, covering consolidation of domestic
banks, issuance of new licenses to foreign banks, liberalization of bank branching restrictions and interest rate deregulation, have
successfully strengthened the capacity of domestic banks to compete with foreign banks and created a competitive playing field in the
country.
* Corresponding author.
E-mail addresses: myong.toh@outlook.com (M.Y. Toh), jdk@cczu.edu.cn (D. Jia).
1
The reforms were governed by the Financial Sector Masterplan 2001− 2010 and have now been succeeded by the Financial Sector Blueprint
2011− 2020.
https://doi.org/10.1016/j.ribaf.2020.101350
Received 27 February 2020; Received in revised form 19 July 2020; Accepted 1 November 2020
Available online 7 November 2020
0275-5319/© 2020 Elsevier B.V. All rights reserved.
M.Y. Toh and D. Jia Research in International Business and Finance 56 (2021) 101350
We maintain that the investigation of the impact of bank market power on liquidity creation for a developing country is important
because bank liquidity creation is the main liquidity source for private sectors and the main driver of the country’s economic growth
(Smith, 1776). However, we contend that the impact of bank market power on liquidity creation may be heterogeneous by bank
ownership type as there are conflicting theoretical grounds that render this question a testable hypothesis. According to the
“home-field advantage” view, foreign banks have a limited ability to access cheap local funding and to extract higher revenues from
providing the same financial solutions as domestic banks due to a lack of competitive advantages to address cultural, institutional,
regulatory and other barriers in host countries (Berger et al., 2000; Sathye, 2001). This could therefore be postulated that market
power is more crucial for sustaining the liquidity creation performance of foreign banks than domestic banks. Conversely, some studies
argue that foreign banks are equipped with superior management, expertise and technologies that allow them to overcome
cross-border barriers including the problems of information asymmetry and weak contract enforcement in host countries (Bruno and
Hauswald, 2014; Lee et al., 2016; Lin, 2011). According to this “global advantage” view, market power plays little role in improving
the performance of foreign banks. It is also worth mentioning that, given the dramatic increase in cross-border bank flow across the
world since 1990s, abundant studies have emerged to examine the efficiency and profitability performance of foreign banks vis-à-vis
domestic banks in host countries (Berger et al., 2000; Hasan and Marton, 2003; Gaganis and Pasiouras, 2009; Jeon et al., 2011; Tigran
and Arsen, 2010). Yet, the question of how the liquidity creation performance of foreign banks vis-à-vis domestic banks in host
countries could be affected by market power remains unexamined.
We further contend that the distance between home and host countries may influence foreign banks’ liquidity creation response to
market power in a host country. Literature has widely found that foreign banks from countries with cultural, economic and institu
tional distance to the host country encounter difficulty in adapting to local environment and exercising their existing competitive
advantages in the host country (Cezar and Escobar, 2015; Dow and Karunaratna, 2006; Ghemawat, 2001; Martín Martín and Dro
gendijk, 2014). As market power is associated with profitability, we expect that a rise in market power could compensate foreign banks
for the cross-border challenges and drive them to better perform in the host country. Hence, the second research objective of this paper
is to investigate whether home-host country distance drives the positive impact of bank market power on liquidity creation of foreign
banks.
Malaysia makes a good representative of developing Southeast Asian countries for a few reasons. First, the Malaysian banking
sector is competitive and diverse in market participants and financial offerings. Owing to a series of banking reform initiatives un
dertaken since 2000, the number of foreign greenfield entry banks in Malaysia spurred from 14 to 23 over the period 2000–2017, while
the then 18 domestic banks were successfully consolidated into 8 banking conglomerates which dominate the market by almost 75 %
today. Foreign banks in Malaysia do not have extensive branch networks throughout the country as they usually base in highly
populated and industrialized cities targeting high value corporate clients, as opposed to the mass and corporate customers served by
the domestic, geographically diversified banks. These differences between domestic banks and foreign banks may lend to a significant
heterogeneity in bank performance within the banking sector.
Second, Malaysia has a large and deep banking sector according to international benchmarks. According to the data from the World
Bank, the domestic bank credit to private sector as a percentage of GDP of Malaysia was 119 percent in the year 2017, as compared to
the U.S. (53 percent), the world average (87 percent) and the ASEAN peer average (74 percent). Meanwhile, the bank deposit as a
percentage of GDP of Malaysia (113 percent) was also exceedingly above the U.S. (80 percent), the world average (63 percent) and the
ASEAN peer average (69 percent). These data highlight the relative importance of the financial intermediation role of banks in
Malaysia. A study of the banking sector of Malaysia is thus more meaningful than other Southeast Asian countries. We focus on a single
country for our research objectives because of two main reasons. First, the cross-country databases, such as BankScope and Fitch
Connect databases, do not provide bank-level data at a sufficient level of disaggregation to allow us identify the detailed category and
maturity information of banks’ on- and off-balance sheet activities required for liquidity creation measurement. We have to manually
collect data from each bank’s financial reports in this regard. Second, the liquidity of bank balance-sheet activities such as residential
mortgages is subject to country heterogeneity such as country’s capital market development. This makes the measurement of liquidity
creation of banks in different countries open to debate.
We first find that the impact of market power is either negative or insignificant for domestic banks but significantly positive for
foreign banks. The results support the “home-field advantage” view and imply that market power is more crucial for foreign banks to
expand liquidity creation in a developing host country, while domestic banks tend to restrain their liquidity creation activities when
their market power rises as they have obtained significant foothold in the market. Moreover, we document the first evidence that
foreign banks originated from countries with cultural, economic and institutional distance to the host country reap greater benefits
from market power when leveraging liquidity creation business, while compared with domestic banks. Our evidence also indicates that
the positive impact of market power on liquidity creation of foreign banks holds, regardless of whether the host country has better or
poorer economic development and institutional quality. Our additional analysis also finds that the influence of home-host country
distance is particularly evident for small foreign banks which have lower franchise value and could be easily eliminated through
competition. These overall results reveal that adverse impact of home-host distance on foreign banks can be alleviated if the banks are
endowed with greater market power which could subsidize their cross-border investment costs.
This study contributes to the literature in several ways. Most importantly, we merge two independent literature strands, which are
(1) the impact of bank market power on liquidity creation and (2) the impact of foreign ownership, and provide evidence of the
heterogeneous impact of bank market power on liquidity creation for domestic banks and foreign banks. The results reveal the
comparative advantages of domestic banks vis-à-vis foreign banks in the host country. We further enrich the global banking literature
by shedding light on the role of host-home country distance in terms of culture, economic development and institution in the impact of
market power on liquidity creation for foreign banks. The results draw attention to the importance of maintaining some degree of
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market power for foreign banks to sustain in the host country. In addition, while the literature on foreign banks’ performance is
extensive in the context of profitability and efficiency performance in host countries, very little is known for their liquidity creation
performance, especially in Southeast Asia. Our study moves beyond prior literature by looking into aggregate liquidity creation and its
components comprising not only the traditional deposit-taking and lending activities, but also the off-balance sheet credit commit
ments and guarantees typically extended to customers on a relationship basis. Our descriptive statistics for bank liquidity creation
indicate that, in an increasingly liberalized banking sector dominated by long-standing domestic banks, foreign banks tend to
specialize in off balance-sheet liquidity creation business in which they have greater comparative advantages to tap.
The paper is organized as follows. Section 2 reviews related literature and develops hypotheses. Section 3 explains the research
method and data. Section 4 presents the results and robustness tests. Section 5 concludes the results and their implications.
2. Literature review and hypotheses development
We review three separate literature strands, being (1) the impact of bank market power on bank liquidity creation, (2) the impact
on bank performance of foreign ownership vis-à-vis domestic ownership, and (3) the impact of home-host country distance on foreign
direct investment (FDI). We then develop hypotheses.
2.1. Impact of bank market power on bank liquidity creation
Horvath et al. (2016) offer the first evidence in this literature strand by showing that Czech banks with lower market power tend to
create less liquidity for the economy in order to reduce the threat of bank runs as competition has harmed the banks’ profitability and
solvency. Along similar line, Toh et al. (2020) find that bank competition hurts bank liquidity creation in Malaysia. Jiang et al. (2019)
also document that bank market power is positively related to the liquidity creation of banks in the U.S. and 25 OECD countries,
respectively. They suggest that banks with lower market power are more conservative in issuing loans and taking deposits, resulting in
a drop in liquidity creation consequently. These prior results suggest that market power could act as a buffer against adverse financial
and market conditions that supports bank performance.
As bank lending is the main channel of liquidity creation, we extend our review to literature examining the impact of bank market
power on bank lending activities. From there, we find conflicting evidence about the effect of bank market power on liquidity creation.
Among the advocators of bank market power, Petersen and Rajan (1995) argue that, in the presence of information asymmetries,
market power allows banks to internalise the benefits of establishing lending relationships with opaque customers, thereby incen
tivizing banks to increase credit supply. Similar argument is also provided by Dell’Ariccia and Marquez (2004) and Zarutskie (2006).
Carletti and Leonello (2011) show that banks with lower market power have an incentive to invest more in liquid reserves and less in
loans because loans are not very profitable for the banks and their opportunity costs of holding reserves are low. In contrast, Beck et al.
(2004) document a negative impact of bank market power on firms’ access to bank credit for 74 developed and developing countries as
banks impose higher financing obstacles on firms. Similar findings are also documented by Carbó-Valverde et al. (2009) for Spain,
Chong et al. (2013) and Shen et al. (2009) for China. The adverse impact of market power on bank liquidity creation could also be
explained by the increased net interest margin imposed by banks on their customers (Berger et al., 2007; Corvoisier and Gropp, 2002;
Fischer and Pfeil, 2004; Heitfield and Prager, 2004). Summing up, the extant literature has produced contradictory evidence regarding
the impact of bank market power on liquidity creation and exposed gaps in our knowledge regarding the role of foreign ownership in
the impact.
2.2. Impact on bank performance of foreign ownership vis-à-vis domestic ownership
With regard to the performance of foreign banks vis-à-vis domestic banks, the extant literature has provided two opposing views: the
“home-field advantage” view and the “global advantage” view. The former argues that domestic banks perform better than foreign
banks in host countries because the cultural, economic, institutional and regulatory obstacles in the countries hamper the ability and
ease of foreign banks to access cheap local funding and earn higher revenues from providing the same financial solutions as domestic
banks (Berger et al., 2000). Consequently, foreign banks encounter greater difficulty in creating and exercising competitive advantages
in host countries and in leveraging their presence in the retail and underserved markets of the countries. Buch and Golder (2001) also
find that the local banking markets are segmented by ownership both in the U.S. and Germany because foreign banks are disad
vantaged when dealing with local customers and assessing credit risk. Sathye (2001) show that foreign banks in the U.S. face stiff
competition from domestic banks as they do not have extensive branch networks and technologies that allow them to service retail
markets at arm’s length. Other studies documenting that domestic banks perform better than foreign banks in terms of profitability,
efficiency and market power include Hasan and Marton (2003); Gaganis and Pasiouras (2009) and Kosmidou et al. (2004).
On the contrary, the “global advantage” view suggests that foreign banks perform better than domestic banks in host countries as
they are well-equipped with strategic management, expertise and technologies that allow them to overcome cross-border obstacles.
For example, Bruno and Hauswald (2014) find that foreign penetration into local banking market eases local firms’ access to bank
credit as foreign banks possess superior lending technologies that could alleviate the problems of information asymmetry and weak
contract enforcement in host countries. Similar result is also reported by Lin (2011) who finds that foreign banks alleviate financial
constraints of less opaque firms in China. Lee et al. (2016) find that foreign banks are competitive and capable of withstanding the
monopoly power of domestic banks in emerging countries. Other studies that have documented superior performance of foreign banks
over domestic banks in terms of market power, profitability, efficiency and loan performance include Barajas et al. (2000), Chen and
3
Liao (2011), Claeys and Hainz (2014), Jeon et al. (2011) and Tigran and Arsen (2010).
Given the conflicting evidence on the performance of foreign banks vis-à-vis domestic banks, we expect that the “home-field
advantage” theory dominates over the “global advantage” theory in the Malaysian banking context. This is because domestic banks in
Malaysia underwent restructuring, consolidation and rationalization reforms mandated by the local authorities in early 2000s before
the banking market was open for foreign participants via liberalization of foreign bank licensing and deregulation of bank branching
restrictions. Having greater scale along with increased investment in technology and talent, domestic banks are now equipped with
strong capacity to resist operational and market risks in the increasingly deregulated and liberalized banking sector. Foreign banks, on
the other hand, may inherit superior resources (such as global network and technology) from their parent companies. However,
without greater scale and local reputation, foreign banks’ competitive position is not as compelling as their domestic counterparts as
local customers often seek financial solutions in a safe and steady name with a sustainable business. Along with narrow business focus,
the liquidity creation performance of foreign banks is hampered subsequently. We thus expect that market power is more crucial for
foreign banks to support their liquidity creation performance than domestic banks. The first hypothesis is as follows:
Hypothesis 1. Bank market power affects liquidity creation more positively for foreign banks than for domestic banks.
2.3. Impact of home-host country distance on foreign direct investment
The extant literature has produced substantial evidence pertaining to the influence of home-host country distance on the perfor
mance of multinational banks in host countries. In international business, the definition of distance is not confined to geographically
distance, but is also extended to cultural, institutional and economic distance (Ghemawat, 2001). Unlike conventional business firms,
banks operate and compete in the financial services industry and their operation is mainly supported by informational and commu
nication technology. The additional operational costs associated with the transfer and set-up of specialized machinery, equipments and
plants across countries, which are typically faced by multinational firms, could therefore be almost disregarded by multinational
banks. Along with the increasingly digitalized, integrated and globalized financial system, geographic distance between host and home
countries may no longer exert a critical hurdle for multinational banks to operate in a foreign country (Conley and Ligon, 2002; Le,
2017). Thus, this paper focuses on the influence of host-home country distance in cultural, institutional and economic terms on the
performance of foreign banks in a host country.
2.3.1. Impact of cultural distance

Cultural distance between home and host countries relates to the differences in religious beliefs, race, social norms and language
between the countries. It determines how people and firms from a country interact with one another in another country and influences
psychical proximity between them. Prior literature has argued that cultural distance can hamper the adaptability of foreign firms to the
host country and increase uncertainty over investment prospects. For example, Dow and Karunaratna (2006) and Martín Martín and
Drogendijk (2014) argue that cultural argue that cultural distance such as language and religious differences could distort the effi
ciency and clarity of information flows across borders and increase uncertainty at foreign markets due to misunderstanding and
misinterpretation of information.
Further, Blonigen and Piger (2014) find that cultural distance is among the main determinants of FDI inflows in the OECD
countries. Claessens and van Horen (2012) and Mian (2006) find that cultural distance imposes a cross-border barrier on foreign banks
as they are unfamiliar with local customs, languages and consumer markets. Their evidence suggests that foreign banks from home
countries which are culturally proximate to the host country learn to adapt to the local environment quickly and may enjoy similar
competitive advantages as local banks. Along the similar line, Du et al. (2012) find that foreign firms originated from countries which
are culturally remote from China have deeper concerns about the institutional quality across China’s regions and that their FDI location
decisions are more sensitive to institutional barriers in the local markets. It is undisputable that the cultural distance between home
and host countries would act as a significant barrier for foreign banks to operate in a host country and make market power more crucial
for supporting foreign banks’ performance in the host country. Thus, the second hypothesis is as follows:
Hypothesis 2. Cultural distance drives the positive impact of market power on the liquidity creation of foreign banks.
2.3.2. Impact of economic distance

Extant literature has found that economic distance (typically measured by GDP distance) between home and host countries could
be a key determinant of multinational firms’ FDI activity and that the direction of economic distance could influence the motives of the
firms’ FDI activity. Ghemawat (2001) reports that host countries that have similar economic profiles allow multinational firms to
pursue economies of scale and scope as the firms could replicate their existing business model and exploit their competitive advantage
in the host country at minimal marginal costs. The study also finds that richer countries also tend to engage more investment activity
with other rich countries due to the effects of economic similarity in the cost and quality of production resources.
Blanc-Brude et al. (2014) examine the location choice of FDI in Chinese prefecture-cities. They find that foreign firms are typically
attracted to richer cities and that cities that are economically and administratively close are likely to experience positive FDI spillovers
from their neighbors. The findings reveal resource exploration motive of foreign firms in a rich local market, for which they offer
several explanations. First, a rich city stipulates greater demand and production potential for the firms’ products. Second, a rich city is
usually an industry agglomeration as well as an agglomeration of foreign investment equipped with mature infrastructure and support
system as well as skilled labor, which could bring many potential economies for foreign firms and reduce liabilities of foreignness.
On the contrary, Le (2017) documents evidence in favor of resource exploitation motive of foreign firms by showing that the
4
economic distance between Vietnam and her partner countries has a significantly positive influence on the country’s bilateral trade
and FDI inflows. Since Vietnam is less developed than most of her FDI donors, the finding suggests that a host country with weaker
economic size and wealth could offer a favorable environment for foreign firms to maintain comparative advantages over local
Vietnamese firms and exploit resources of the country. Similarly, Kandogan (2016) reveals that cultural distance exerts a bigger barrier
for multinational firms from developing countries than multinational firms from developed countries because the latter are better
equipped with capital that allows them to take greater risk in the culturally-distant host country. Meanwhile, multinational firms from
developing countries demonstrate domestic bias in their investment location decisions due to their familiarity with their own culture.
It is noted that, while positive or negative economic distance between home and host countries could provide foreign firms with
opportunities of resource exploitation and exploration, respectively, the presence of economic distance could still be a key hurdle for
foreign direct investment in host countries. Thus, we develop the third hypothesis as follows:
Hypothesis 3. Economic distance drives the positive impact of market power on the liquidity creation of foreign banks.
2.3.3. Impact of institutional distance

Institutional quality of a country reflects the government’s commitments to enhancing rule of law, regulatory efficiency, gov
ernment size and market openness, which lays the foundation for economic growth (Miller et al., 2019). Regarding the influence of
institutional quality and distance on FDI, Demirbag et al. (2011) show that economic freedom difference between Japan and host
countries has a negative impact on the survival of Japanese foreign subsidiaries in the Middle East and North Africa region as the
institutional distance creates uncertainty and additional costs associated with different practices and levels of trust in doing business in
the new environment. Arslan et al. (2015) examine the effects of economic freedom distance on both FDI establishment and ownership
mode strategies of MNEs. Their evidence reveal that Nordic MNEs prefer greenfield investments and joint ventures when investing in a
host country with weaker economic freedom because these establishment and ownership modes allow the firms to overcome unfa
miliarity hazards in the host country.
Cezar and Escobar (2015) provide both theoretical and empirical evidence for the negative impact of institutional distance on
outward and inward FDI in 31 OECD countries. They explain that greater institutional distance between home and host countries
would increase adaptation costs of multinational firms and subsequently reduce the firms’ profitability and incentives to invest
overseas. Bojnec and Fertő (2018) find that FDI outflow of OECD countries is driven positively by the levels of globalization,
corruption-free and cross-country similarity of the host country. Using a large cross-country dataset, Li et al. (2020) and Buchanan
et al. (2012) find that the institutional differences in government effectiveness and control of corruption between China and host
countries have a negative effect on China’s OFDI. Similarly, Brada et al. (2012) show that the level of corruption in six East European
transition economies is negatively related to the likelihood of multinational firms locating in those economies.
Unlike prior studies, Aleksynska and Havrylchyk (2013) show that institutional distance has an asymmetric effect on FDI
depending on the level of institutional quality of the host country in relation to the home country. Specifically, institutional distance
exerts a negative effect on FDI inflows in host countries with worse institutions (negative institutional distance) and such a negative
effect can be alleviated if host countries are endowed large reserves of natural resources that compensate foreign investors for the
additional costs associated with poor institutions. On the contrary, institutional distance has a positive effect on FDI inflows in host
countries with positive institutional distance as it is viewed as a driving force for emerging foreign investors to acquire better tech
nologies and knowledge in a better institutional environment. Notwithstanding, the extant literature has produced sufficient evidence
that institutional distance could act as a hurdle that refrains foreign subsidiaries from exercising competitive advantages that are
similar to their parent firms. Thus, we expect that the performance of foreign banks in a host country is more sensitive to an increase in
their market power.
Hypothesis 4. Institutional distance drives the positive impact of market power on the liquidity creation of foreign banks.
3. Research method
3.1. Data
Our sample covers nearly all the conventional and Islamic commercial banks operating in Malaysia from 2001 to 2017. In the event
of mergers and acquisitions, the involved banks are treated separately before the event as long as the data are reported separately. The
acquired bank data is not available after the event. After omitting banks with insufficient or missing data, the sample is left with an
unbalanced panel of 45 banks with a total of 582 bank-year observations, which accounts for 97 percent of total assets in the banking
sector. The final sample consists 21 domestic banks and 24 greenfield entry foreign banks (see Appendix A for the bank list). The
unconsolidated bank data is obtained from banks’ annual reports, Bureau van Dijk’s Bankscope database and Fitch Connect database.
Cross-country macroeconomic and institutional data are obtained from the World Bank and the Heritage Foundation websites,
respectively, whereas macroeconomic data of Malaysia are obtained from the Department of Statistics Malaysia.
3.2. Measurement of variables
3.2.1. Bank liquidity creation

We adopt the widely used approach of measuring bank liquidity creation, that is, the three-step framework developed by Berger
and Bouwman (2009). Specifically, step one involves classifying all banks’ on- and off-balance sheet activities as liquid, semi-liquid or
5
illiquid using the category (Cat) and maturity (Mat) information of the activities (refer to Appendix B for details). Step two involves
assigning a weight of 1/2, 0 or -1/2 to all the activities classified in step one following the liquidity creation concept that both sources
and uses of funds contribute equally to liquidity creation. In step three, the weights of 1/2, 0 or -1/2 assigned in step two are multiplied
by the MYR value of the respective balance sheet items, then the weighted MYR values are summed up to arrive at the total MYR
amount of liquidity creation by the bank. Following Berger and Bouwman’s (2009) approach, we construct four alternative liquidity
creation measures denoted as CATFAT and MATFAT for aggregate liquidity creation incorporating all balance sheet and off-balance
sheet activities and as CATNONFAT and MATNONFAT for liquidity creation incorporating only balance sheet activities using “Cat”
and “Mat” specification, respectively. We also construct an additional measure incorporating only off-balance sheet activities and
denote it as OFFLC. All liquidity creation measures are scaled by total assets to make liquidity creation comparable across banks.
We note that some minor adjustments have been made by some subsequent studies to suit data limitation and country context. For
example, the recent study of Berger et al. (2019) and Fu et al. (2016) examine bank liquidity creation for a large set of countries and
have to rely on the cross-country BankScope database, for bank-level financial data. Unfortunately, BankScope database does not
provide bank-level data at a sufficient level of disaggregation. For example, maturity information of bank loans and deposits and fair
values of off-balance sheet derivatives are not provided by the database, so the authors are forced to disregard this information in
liquidity creation measurement. Since our study focuses on a single country, it is feasible to manually collect detailed data from each
bank’s financial reports and follow Berger and Bouwman’s (2009) approach to arrive at comprehensive and all-rounded liquidity
creation measures. As such, we are able to construct aggregate and balance-sheet liquidity creation measures based on “Cat” and “Mat”
specifications, whereas Berger et al. (2019) and Fu et al. (2016) manage to construct “Cat”-specified liquidity creation measures only.
In the study of Berger et al. (2019), balance-sheet liquidity creation is further divided into liquidity creation on the asset side and
liquidity creation on the liability side. By separating both source of funds (liabilities) and use of funds (assets), these measures are
Table 1
Definitions and summary statistics of variables.
Variable Definition Mean S.D.
Bank liquidity creation (LC)

CATFAT Aggregate bank LC based on category specification approach. LC is scaled by total assets of bank 0.25 0.40
CATNONFAT Balance-sheet LC based on category specification approach. LC is scaled by total assets of bank 0.054 0.17
MATFAT Aggregate bank LC based on maturity specification approach. LC is scaled by total assets of bank 0.41 0.41
MATNONFAT Balance-sheet LC based on maturity specification approach. LC is scaled by total assets of bank 0.21 0.25
OFFLC Off balance-sheet LC scaled by total assets of bank 0.20 0.37
Bank market power
NIM Interest spread between loans and deposits 0.040 0.030
LERNER Lerner index of market power 0.17 0.18
Bank size Natural log of total assets 9.94 1.43
lnTA
Bank capital ratio Capital adequacy ratio measured by a ratio of total regulatory capital to risk-weighted assets 0.22 0.23
RWCR
Bank risk Liquid assets (cash and securities) divided by liquid liabilities (demand deposits and other short-term funding) 0.39 0.36
LIQ Risk-weighted assets divided by total assets 0.61 0.16
CREDIT_RISK
Domestic economic environment
MP Real overnight interbank rates 0.030 0.004
GDPRATE Real GDP growth rate 0.049 0.021
Foreign ownership and home-host country distance dummies
dFOREIGN A dummy variable equals one if the bank is foreign-owned, zero otherwise n/a n/a
dSDIST A dummy variable equals one if the parent of the foreign bank is headquartered in the Southeast Asian region, zero n/a n/a
otherwise
dLDIST A dummy variable equals one if the parent of the foreign bank is headquartered outside of the Southeast Asian region, zero n/a n/a
otherwise
dHGDPCONS A dummy variable equals one if the foreign bank is originated from a country with a constant GDP value higher than that n/a n/a
of Malaysia’s in the specific year, zero otherwise
dLGDPCONS A dummy variable equals one if the foreign bank is originated from a country with a constant GDP value lower than that of n/a n/a
Malaysia’s in the specific year, zero otherwise
dHGDPRATE A dummy variable equals one if the foreign bank is originated from a country with a GDP growth rate higher than that of n/a n/a
dLGDPRATE A dummy variable equals one if the foreign bank is originated from a country with a GDP growth rate lower than that of n/a n/a
dHECOFREE A dummy variable equals one if the foreign bank is originated from a country with an economic freedom index higher than n/a n/a
that of Malaysia’s in the specific year, zero otherwise
dLECOFREE A dummy variable equals one if the foreign bank is originated from a country with an economic freedom index lower than n/a n/a
dHFINFREE A dummy variable equals one if the foreign bank is originated from a country with a financial freedom index higher than n/a n/a
dLFINFREE A dummy variable equals one if the foreign bank is originated from a country with a financial freedom index lower than n/a n/a
Source: Banks’ annual reports, Bureau van Dijk’s Bankscope database, Fitch Connect database, the Heritage Foundation website, the World Bank
website and authors’ calculations.
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incomplete representations of bank liquidity creation, however. This is because only when liability funds are used to finance assets,
bank liquidity creation is complete. Furthermore, Berger et al.’s (2019) approach slightly differs from that of Berger and Bouwman
(2009) in the classification of residential mortgage loans into liquidity classes. As Berger and Bouwman’s (2009) approach is designed
for application to the U.S., residential mortgage loans are classified as semi-liquid assets for banks due to the moderate ease of asset
securitization in the U.S.’s capital market. However, in the cross-country study of Berger et al. (2019), mortgage loans are classified as
semi-liquid for high-income countries and illiquid for low-income countries. In the context of Malaysia, residential mortgages and
consumer loans are easily sold to the secondary debt market via to the national securitization house, Cagamas. Hence, we follow Berger
and Bouwman (2009) and classify these loans as semi-liquid assets.
3.2.2. Bank market power and control variables

Considering the interest spread between loans and deposits is the fundamental and major income source of commercial banks, we
measure bank market power by the interest spread between loans and deposits. A higher interest spread of a bank implies a greater
ability to extract profit from financial intermediation activities (Andrievskaya and Semenova, 2016; Hawtrey and Liang, 2008; Maudos
and Fernández de Guevara, 2004). Bank market power variable is labeled as NIM. We also employ the Lerner index as an alternative
measure of market power in our robustness test which will be explained later.
Our bank-specific control variables (BankControls) include bank size, capital ratio, liquidity risk and credit risk. We control for bank
size (lnTA) because banks of different sizes have different comparative advantages in lending technology adoption and target markets,
which may influence their liquidity creation subsequently (Berger and Black, 2011; Stein, 2002). Bank capital ratio (RWCR) is
controlled because an increase in bank equity capital could either crowd out deposit funding required for liquidity creation or
encourage liquidity creation by absorbing risks associated with lending and expanding banks’ risk-bearing capacity (Berger and
Bouwman, 2009). We also control for bank liquidity risk (LIQ) because it may influence the liquid funding the bank makes available for
the economy. It is also important to control for banks’ credit risk stance (CREDIT_RISK) as it reflects the banks’ tolerance to risk when
extending loans to customers (Berger and Bouwman, 2009; Horvath et al., 2016). With regard to MacroControls, we control for the
monetary policy stance determined by the Central Bank of Malaysia and the economic growth using real overnight interbank rate (MP)
and real economic growth rate (GDPRATE), respectively, as macroeconomic changes may influence bank liquidity creation through
changes in banks’ balance sheet structure (Berger and Bouwman, 2017; Ibrahim, 2016). Table 1 presents the measurements and
summary statistics of all variables used in this paper.
3.2.3. Foreign ownership and home-host country distance

We first create a dummy variable for bank ownership type which equals one if the bank is foreign-owned, zero if the bank is a
domestic bank (dFOREIGN). To further identify the home-host country distance of foreign banks in cultural, economic and institutional
aspects, we maintain domestic banks as the reference group and create several dummy variables for home-host country distance of
foreign banks (refer to Table 1 for definitions of these dummies). For cultural distance, we regard home countries outside of the
Southeast Asian region as culturally distant from Malaysia and home countries within the region as culturally proximate to Malaysia
because Southeast Asian countries tend to share similar languages, religions, colonial history and social norms. In our study sample,
related Southeast countries are Singapore and Thailand. Thus, the dummy variable dSDIST taking the value of one denotes the foreign
bank originated from these Southeast Asian countries, and the dummy variable dLDIST taking the value of one denotes the foreign bank
originated from outside of Southeast Asian region.
As regard to economic distance, we use constant GDP value and annual GDP growth rate to measure a country’s economic
development. Since prior studies such as those of Aleksynska and Havrylchyk (2013), Blanc-Brude et al. (2014) and Le (2017) have
reported that the direction of economic distance has an assymmetric effect on the motive and strategy of foreign direct investment in a
host country, we classify foreign banks from countries with higher constant GDP value (annual GDP growth rate) than that of Malaysia
as positive economic distance and vice versa as negative economic distance, then denote them separately using a dummy variable
dHGDPCONS (dHGDPRATE) taking the value of one and a dummy variable dLGDPCONS (dLGDPRATE) taking the value of one,
respectively. For these dummy variables, we maintain domestic banks as the reference group. Such classification approach allows us to
identify the direction of economic distance that suppresses foreign banks’ competitive advantages in the host country.
Similarly, we classify foreign banks into positive institutional distance and negative institutional distance using two alternative
institutional measures, specifically the economic freedom index and the financial freedom index developed by the Heritage Foun
dation. These indices range from 0 for the weakest to 100 for the strongest. The economic freedom index is an overall score measuring
four institutional aspects of economic freedom of a country, which are rule of law, government size, regulatory efficiency and market
openness. It reflects the conduciveness of a country’s entrepreneurial environment in resolving a wide range of economic and social
challenges faced by most of the world’s societies including banks. Compared to the economic freedom index, the financial freedom
index is a specific measure of a country’s financial market openness which reveals the extant of financial liberalization and deregu
lation, the transparency and integrity of information disclosure and the effectiveness of regulatory system in the country’s financial
system. Distance of financial freedom between home and host countries is a particularly important factor of consideration of multi
national banks’ expansion to other countries as it directly affects the banks’ operational efficiency and ability to compete on an equal
level in the host countries. We maintain domestic banks as the reference group and denote foreign banks from countries with higher
economic freedom index (financial freedom index) than that of Malaysia using a dummy variable dHECOFREE (dHFINFREE) taking the
value of one and foreign banks from countries with lower economic freedom index (financial freedom index) than that of Malaysia
using a dummy variable dLECOFREE (dLFINFREE) taking the value of one.
7
3.3. Empirical models
We first examine whether and how ownership type (domestic ownership versus foreign ownership) makes a difference to the
impact of bank market power on bank liquidity creation. The employed regression specification is as follows:
LCit = β0 + β1 NIMit− 1 + β2 NIMit− 1 ∗ dFOREIGNit− 1 + δ’ BankControlsit− 1 + γ ’ MacroControlst− 1 + Fi + eit (1)
where the dependent variable, LCit, is the liquidity creation of bank i in year t which is alternatively represented by CATFAT, CAT
NONFAT, MATFAT, MATNONFAT and OFFLC. NIM measures bank market power. NIM*dFOREIGN is an interaction term of NIM and a
dummy variable for bank ownership which equals one if the bank is foreign-owned, zero otherwise (dFOREIGN). BankControls rep
resents a vector of bank-specific control variables. MacroControls represents a vector of macroeconomic control variables. The defi
nitions and summary statistics of these variables are provided in Table 1. All the explanatory variables are one-year lagged to alleviate
potential endogeneity problem arising from simultaneity and omission bias. The regression is estimated using the OLS method with
cluster-robust standard errors and with bank-fixed effects (Fi) controlled for bank heterogeneity. e is the idiosyncratic error term. A
standalone dFOREIGN dummy is not included in Eq. (1) because it is also a bank-fixed effect variable for which Fi has accounted. β, δ
and γ are the coefficients to be estimated. We are particularly interested in the coefficients β1 and β2. The coefficient β1 indicates the
marginal effect of bank market power on the liquidity creation of a domestic bank, while the coefficient β2 measures the effect on the
market power-liquidity creation relationship of a shift from a domestic bank to a foreign bank. A positive and statistically significant β2
provides evidence supporting Hypothesis 1.
To shed more light onto the influence of host-home country distance in culture, economic development and institution on foreign
banks, we maintain domestic banks as the reference group and replace dFOREIGN in Eq.(1) by different home-host country distance
dummies in separate regressions, as specified in Eqs. (2) to (6).
LCit = β0 + β1 NIMit− 1 + β2 NIMit− 1 ∗ dSDISTit− 1 + β3 NIMit− 1 ∗ dLDISTit− 1 + δ’ BankControlsit− 1 + γ’ MacroControlst− 1

(2)
+ Fi + eit
LCit = β0 + β1 NIMit− 1 + β2 NIMit− 1 ∗ dHGDPCONSit− 1 + β3 NIMit− 1 ∗ dLGDPCONSit− 1 + δ’ BankControlsit− 1

(3)
+ γ’ MacroControlst− 1 + Fi + eit
LCit = β0 + β1 NIMit− 1 + β2 NIMit− 1 ∗ dHGDPRATEit− 1 + β3 NIMit− 1 ∗ dLGDPRATEit− 1 + δ’ BankControlsit− 1

(4)
LCit = β0 + β1 NIMit− 1 + β2 NIMit− 1 ∗ dHECOFREEit− 1 + β3 NIMit− 1 ∗ dLECOFREEit− 1 + δ’ BankControlsit− 1

(5)
LCit = β0 + β1 NIMit− 1 + β2 NIMit− 1 ∗ dHFINFREEit− 1 + β3 NIMit− 1 ∗ dLFINFREEit− 1 + δ’ BankControlsit− 1

(6)
Specifically, Eq. (2) is designed to test the role of cultural distance in the impact of bank market power on liquidity creation of
foreign banks in the host country, whereas Eqs. (3) and (4) reveal the role of economic distance, and Eqs. (5) and (6) reveal the role of
institutional distance. In Eqs. (2) to (6), a statistically significant and positive coefficients β2 and (or) β3 will confirm Hypotheses 2–4.
All the regressions are estimated using OLS method with cluster-robust standard errors.
Table 2
t-test of mean differences in bank-specific variables between domestic banks and foreign banks.
(1) (2) t-statistic
Foreign banks Domestic banks mean(1) - mean(2)
(dFOREIGN = 1) (dFOREIGN = 0)
CATFAT 0.29 0.21 2.54**

CATNONFAT 0.032 0.077 − 3.31***
MATFAT 0.37 0.44 − 2.20**
MATNONFAT 0.11 0.32 − 11.0***
OFFLC 0.26 0.13 4.31***
NIM 0.038 0.041 − 1.02
LERNER 0.16 0.17 − 0.16
lnTA 9.21 10.71 − 14.79***
RWCR 0.28 0.15 7.45***
LIQ 0.51 0.27 8.73***
CREDIT_RISK 0.61 0.61 0.12
No. of obs. 298 284
Notes: The table reports the t-test of differences in means of bank-specific variables between foreign banks and domestic banks. All variables are
defined in Table 1. *** and ** denote one and five percent significance levels, respectively.
8
4. Results
4.1. Descriptive statistics
We perform two-tailed t-tests of mean differences in bank-specific variable between foreign banks and domestic banks and report
the results in Table 2. We first note that CATNONFAT, MATNONFAT and MATFAT of domestic banks are significantly greater than
those of foreign banks, while CATFAT and OFFLC are significantly greater for foreign banks. In other words, domestic banks undertake
balance-sheet liquidity creation function at a significantly greater magnitude than foreign banks, while foreign banks create most
liquidity for the economy off their balance sheets. Whether or not domestic banks engage in greater aggregate liquidity creation than
foreign banks is dependent on the “Cat” or “Mat” specification of liquidity creation. These results reveal that domestic banks create
most liquidity for the economy via balance mainly via the conventional mechanisms characterized by loan issuance and deposit taking
activities, while foreign banks specialize in off-balance sheet mechanisms such as credit commitment issuances, possibly due to the
small target market and limited local market penetration of foreign banks in the country. Second, we note that market power of foreign
banks is lower than that of domestic banks, although the difference is not statistically significant. Third, bank size (lnTA) is significantly
larger for domestic banks than foreign banks. This is not surprising because domestic banks dominate almost three quarters of local
market shares in assets, loans and deposits. Lastly, we find that the financial stability of foreign banks is generally better than that of
domestic banks, as indicated by the significantly higher capital adequacy ratio (RWCR) and liquidity ratio (LIQ). Domestic banks are
generally more risk tolerant because their scale and long-standing local brand name have inherently granted them a legitimate status in
the local society which coerces the government to act as the lender of last resort in the case of bank failure. On the other hand, foreign
banks, which do not only have to safeguard against risks associated to information asymmetry and financial fragility, but also have to
resolve the operating barriers in the host country, are forced to maintain greater solvency and liquidity within themselves.
4.2. Bank ownership type, market power and liquidity creation
Table 3 reports the impact of bank ownership type (domestic versus foreign ownership) on the relationship between bank market
power and liquidity creation. Columns 1–5 in Table 3 differ in bank liquidity creation measures, represented by CATFAT, CATNONFAT,
MATFAT, MATNONFAT and OFFLC, respectively. We first note that the coefficient on l.NIM is negative and statistically significant for
CATNONFAT, MATFAT and MATNONFAT liquidity creation measures and significantly positive for OFFLC liquidity creation measure.
This finding suggests that bank market power affects the balance-sheet liquidity creation of domestic banks negatively and the banks’
off balance-sheet liquidity creation positively. More importantly, the coefficient on the interaction term l.(NIM*dFOREIGN) is positive
and significant for all the liquidity creation measures, suggesting that aggregate, on- and off-balance sheet liquidity creation of foreign
banks is significantly higher than that of domestic banks for a given rise in market power. These results therefore support Hypothesis 1.
The results also carry economic significance. Take on-balance sheet liquidity creation as an example, for an 1% rise in market power,
Table 3
Impact of bank market power on liquidity creation by ownership type.
Dependent variable CATFAT CATNONFAT MATFAT MATNONFAT OFFLC
(1) (2) (3) (4) (5)
l.NIM 0.46 − 0.99*** − 1.82** − 3.27*** 1.45**

(0.69) (-3.86) (-2.48) (-6.73) (2.46)
l.(NIM*dFOREIGN) 8.75** 1.10*** 10.90*** 3.25*** 7.65**
(2.44) (3.05) (3.08) (5.63) (2.11)
l.lnTA 0.054* 0.037*** 0.14*** 0.13*** 0.017
(1.65) (2.69) (4.17) (6.98) (0.60)
l.RWCR − 0.48*** − 0.22*** − 0.40** − 0.14*** − 0.26*
(-2.82) (-5.14) (-2.49) (-3.28) (-1.67)
l.CREDIT_RISK 0.48 0.036 0.47 0.023 0.44
(1.42) (1.09) (1.40) (0.60) (1.37)
l.LIQ − 0.078 − 0.065** − 0.11 − 0.10*** − 0.013
(-1.05) (-2.09) (-1.49) (-2.86) (-0.21)
l.MP 5.94 1.76 0.94 − 3.23** 4.18
(1.57) (1.47) (0.25) (-2.06) (1.19)
l.GDPRATE − 0.90* − 0.39* − 0.46 0.047 − 0.51
(-1.74) (-1.85) (-0.86) (0.19) (-1.10)
Constant − 0.76** − 0.28* − 1.31*** − 0.83*** − 0.48
(-1.97) (-1.84) (-3.32) (-4.37) (-1.44)
Bank-fixed effects Yes Yes Yes Yes Yes
Adj. R2 0.38 0.72 0.43 0.81 0.36
Observations 536 536 536 536 536
The table reports the estimation results regarding the impact of bank market power on the liquidity creation of domestic banks vis-à-vis foreign banks.
We here estimate Eq. (1). The liquidity creation dependent variable used in column (1) to column (5) is represented by CATFAT, CATNONFAT,
MATFAT, MATNONFAT and OFFLC, respectively. The explanatory variables of interest here are l.NIM and l.(NIM*dFOREIGN). All regressions are
estimated using the OLS method with bank-fixed effects controlled. We report t-statistics based on cluster-robust standard errors in parenthesis. ***,
**, * denote significance at one, five and ten percent levels, respectively. All variables are defined in Table 1.
9
CATNONFAT and MATNONFAT of domestic banks shrink by 0.99 % and 3.27 %, respectively, while foreign banks react in an opposite
manner and create liquidity by 1.10 % and 3.25 % more than those of domestic banks (see columns 2 and 4). Similar observation is also
noted for off-balance sheet liquidity creation (OFFLC) as foreign banks create 7.65 % more liquidity for the economy than domestic
banks when their market power increases by 1% (see column 5).
Our overall results reveal that market power is more crucial for foreign banks than for domestic banks in expanding liquidity
creation business, probably because foreign banks lack competitive advantages in host countries, especially in the conventional
lending and deposit-taking activities. In a host country like Malaysia where domestic banks dominate the market and serve the mass
consumers and corporate customers at arm’s length, foreign banks typically target a small market based on high value corporate clients
or customers from their home country. They do not have extensive branch networks and labour force throughout the country and a
wide access to retail markets where they can create new sources of market power by capturing customers who have limited access to
external funding and investment options (Berger et al., 2000; Kosmidou et al., 2004; Sathye, 2001). Foreign banks are forced to
compete with domestic banks in liquidity creation business while tolerating interest margin compression. Some degree of market
power is therefore more desirable for foreign banks as it entitles the banks to greater capability to capture customers and share in their
wallets (Petersen and Rajan, 1995; Dell’Ariccia and Marquez, 2004; Horvath et al., 2016). Domestic banks, on the other hand, enjoy
home-field advantages that allow them to exploit their market power by restraining liquidity creation volume, while charging higher
prices and imposing more rigid terms and conditions on their products due to customer loyalty to long-standing local brand name.
As for control variables, we first note that the coefficient on bank size (l.lnTA) is positive and statistically significant for all the
aggregate and on-balance sheet liquidity creation measures. This result points to economies of scale of large banks in relation to
extensive branch networks, technology diffusion and capital that allow them to leverage their liquidity creation business efficiently
(Berger and Black, 2011; Stein, 2002). Further, banks with higher capitalization ratio (l.RWCR) and liquidity ratio (l.LIQ) create less
liquidity for the economy both on and off balance sheets as these banks practise more prudential management policies. This result is
consistent with the findings of Berger and Bouwman (2009) and Toh (2019). We also offer some evidence for the bank lending or credit
channel of monetary policy, as indicated by a negative coefficient on l.MP (overnight interbank rate) in the regression of MATNONFAT
(on-balance sheet liquidity creation). This result is in conformity with existing studies such as Rashid et al. (2020) and Morris and
Sellon (1995). A rise in overnight interbank rate increases banks’ cost of funds and affects their lending decisions directly. Banks may
voluntarily impose credit rationing among customers or pass the additional cost of funds to customers if they are to maintain their
target for loan growth. All of these strategies would eventually lead to less credit issuances and liquidity creation for the economy.
Lastly, our results offer some evidence for the counter-cyclicality pattern of bank liquidity creation as the coefficient on l.GDPRATE is
negative and significant in CATFAT and CATNONFAT regressions. Malaysian banks demonstrate the ability to stabilize liquidity
condition in the local economy as they inject more liquidity for use of private sectors when the economy deteriorates and vice versa
when the economy grows.
4.3. Home-host country distance, market power and liquidity creation
As documented above, market power is a key driver for foreign banks to expand their liquidity creation business in the host country.
Such a phenomenon could be explained by the host-home country distance of foreign direct investment that exerts a hurdle for foreign
banks to exercise similar competitive advantages as their parent banks and domestic banks. We investigate the influence of host-home
country distance from the cultural, economic and institutional perspectives and report the respective results in Tables 4–6. In those
tables, columns 1–5 differ in bank liquidity creation measures, represented by CATFAT, CATNONFAT, MATFAT, MATNONFAT and
OFFLC, respectively.
Table 4 reports the regression results of Eq. (2) pertaining to the role of cultural distance in the impact of bank market power on
liquidity creation. The results of our particular interest are the coefficients on l.NIM, l.(NIM*dSDIST) and l.(NIM*dLDIST). Since do
mestic banks are treated as the reference group for dSDIST and dLDIST dummies (i.e. foreign banks experiencing short and long cultural
distance), the negative coefficient on l.NIM in the CATNONFAT, MATFAT and MATNONFAT liquidity creation regressions affirm our
earlier finding that domestic banks with greater market power perform less balance-sheet liquidity creation as they tend to practise
higher interest margins between loans and deposits and impose more stringent terms and conditions on their customers. Comparing the
coefficient on l.(NIM*dSDIST) with that on l.(NIM*dLDIST), we find that the former is significantly positive only for MATNONFAT,
while the latter is significantly positive for all liquidity creation measures. To interpret the economic significance of these results, we
continue with the earlier example of on-balance sheet liquidity creation. We note that, for a 1% rise in market power, CATNONFAT of
domestic banks shrink by about 0.99 %, while foreign banks react in an opposite manner. Specifically, foreign banks of which dSDIST
equals one create liquidity for the host country by 2.06 % more than that of domestic banks, although such difference is not statistically
significant. In comparison, foreign banks of which dLDIST equals one create 1.06 % more liquidity than domestic banks, and such
difference is statistically significant. In other words, foreign banks of which home country is culturally distant to Malaysia tend to
create more liquidity when their market power increases, and the positive impact of market power is less significant for foreign banks
originated from countries which are culturally proximate. Since countries within Southeast Asian region usually share similar religious
beliefs, race, social norms and language, such cultural proximity can fasten the adaptability of foreign banks to local market in
Malaysia and alleviate the negative impact of host-home country differences on foreign banks. For example, the sharing of the same
cultural heritage enables foreign banks from Singapore to learn quickly how to tap into niche markets in Malaysia. These foreign banks
possess the ability to compete with domestic banks on an equal level and thus are less responsive to a change in market power, as
compared to foreign banks originated from outside of Southeast Asian region which value a rise of market power more when expanding
liquidity creation business in the host country. We thereby document evidence supporting Hypothesis 2 that cultural distance drives
10
Table 4
Impact of bank market power on liquidity creation by cultural distance.
Dependent variable CATFAT CATNONFAT MATFAT MATNONFAT OFFLC
(1) (2) (3) (4) (5)
l.NIM 0.45 − 0.99*** − 1.83** − 3.27*** 1.44**

(0.68) (-3.85) (-2.48) (-6.73) (2.44)
l.(NIM*dSDIST) 0.95 2.06 3.23 4.34** − 1.11
(0.39) (1.29) (1.23) (2.37) (-0.84)
l.(NIM*dLDIST) 9.01** 1.06*** 11.16*** 3.21*** 7.95**
(2.47) (2.92) (3.10) (5.52) (2.16)
l.lnTA 0.058* 0.037*** 0.15*** 0.13*** 0.021
(1.73) (2.67) (4.22) (6.97) (0.73)
l.RWCR − 0.48*** − 0.22*** − 0.41** − 0.14*** − 0.27*
(-2.83) (-5.12) (-2.50) (-3.27) (-1.69)
l.CREDIT_RISK 0.48 − 0.22*** 0.47 0.023 0.44
(1.42) (-5.12) (1.40) (0.60) (1.37)
l.LIQ − 0.066 − 0.067** − 0.10 − 0.10*** 0.001
(-0.90) (-2.08) (-1.35) (-2.83) (0.019)
l.MP 5.58 1.80 0.60 − 3.18** 3.78
(1.46) (1.50) (0.15) (-2.03) (1.06)
l.GDPRATE − 0.92* − 0.38* − 0.49 0.050 − 0.54
(-1.79) (-1.84) (-0.91) (0.20) (-1.16)
Constant − 0.76** − 0.28* − 1.31*** − 0.82*** − 0.48
(-1.98) (-1.84) (-3.33) (-4.36) (-1.45)
Bank-fixed effects Yes Yes Yes Yes Yes
Adj. R2 0.38 0.72 0.43 0.81 0.36
Observations 536 536 536 536 536
Notes: The table reports the estimation results of the impact of bank market power on liquidity creation by cultural distance. We here estimate Eq. (2).
The liquidity creation dependent variable used in column (1) to column (5) is represented by CATFAT, CATNONFAT, MATFAT, MATNONFAT and
OFFLC, respectively. The explanatory variables of interest here are l.NIM, l.(NIM*dSDIST) and l.(NIM*dLDIST). All regressions are estimated using the
OLS method with bank-fixed effects controlled. We report t-statistics based on cluster-robust standard errors in parenthesis. ***, **, * denote sig
nificance at one, five and ten percent levels, respectively. All variables are defined in Table 1.
the positive impact of market power on liquidity creation of foreign banks.

Table 5 reports the regression results of Eqs. (3) and (4) pertaining to the role of economic distance in the impact of bank market
power on liquidity creation. Economic distance in Panel A of the table is represented by distance in constant GDP value, and economic
distance in Panel B is represented by distance in GDP growth rate. It is found that the coefficients on l.(NIM*dHGDPCONS) and l.(NIM*
dLGDPCONS) in Panel A and the coefficients on l.(NIM*dHGDPRATE) and l.(NIM*dLGDPRATE) in Panel B are positive and statistically
significant across columns (1) to (5). This means that, regardless of the economic distance measure used and the direction of economic
distance, foreign banks perform more aggregate, on- and off-balance sheet liquidity creation for the host country than domestic banks,
for a given increase of market power level. In terms of economic significance, foreign banks with positive distance in GDP value (GDP
growth) create 9.13 % (6.32 %) more aggregate liquidity (CATFAT) than domestic banks in the local economy, while foreign bank with
negative distance in GDP value (GDP growth) create 2.76 % (8.93 %) more aggregate liquidity than domestic banks. The results
support Hypothesis 3 and commensurate with the findings of Ghemawat (2001) and Le (2017) that economic distance is a key barrier
and determinant of foreign investment in a target country. While investment location choice of foreign banks is motivated by the
resource exploitation and exploration opportunities in the target country, they unavoidably encounter challenges arising from eco
nomic differences between home and host countries, such as differences in consumer wealth, labour cost and quality and industrial
structure, which could hamper the ability of foreign banks to replicate their existing business model and exercise their competitive
advantages effectively in the host country. These economic differences could increase the operating costs of foreign banks. Thus, a rise
in market power could incentivize foreign banks to expand deposit-taking, loan issuance and liquidity creation business in the local
market.
We also investigate the influence of institutional distance between home and host countries and report the regression results of Eqs.
(5) and (6) in Panels A and B of Table 6. As indicated by the positive and statistically significant coefficients on l.(NIM*dHECOFREE), l.
(NIM*dLECOFREE), l.(NIM*dHFINFREE) and l.(NIM*dLFINFREE) across columns (1) to (5), foreign banks originated from countries
with higher and lower institutional quality respond to an increase in market power favorably by creating more liquidity on and off their
balance sheets for the host country. In terms of economic significance, we refer to the results in column (1) and observe that foreign
banks with positive economic freedom (financial freedom) distance create 8.82 % (8.78 %) more aggregate liquidity than domestic
banks for local economy, while foreign bank with negative economic freedom (financial freedom) distance also create aggregate
liquidity by 6.61 % (11.40 %) more than domestic banks. Hypothesis 4 is thus supported. As have been reported by prior studies such as
Cezar and Escobar (2015) and Demirbag et al. (2011), foreign firms are sensitive to institutional distance between home and host
countries as the dual pressures from both countries increase the adaptation costs of the firms and restrain their optimal performance in
the host country. Our results add to the extant literature by showing that such adverse impacts can be alleviated if foreign banks are
endowed with greater market power which could compensate them for the additional costs associated with institution differences.
11
M.Y. Toh and D. Jia
Table 5
Impact of bank market power on liquidity creation by economic distance.
Panel A: Distance in GDP value as an economic distance proxy Panel B: Distance in GDP growth rate as an economic distance proxy
Dependent variable CATFAT CATNONFAT MATFAT MATNONFAT OFFLC CATFAT CATNONFAT MATFAT MATNONFAT OFFLC
(1) (2) (3) (4) (5) (1) (2) (3) (4) (5)
l.NIM 0.40 − 0.98*** − 1.87** − 3.25*** 1.38** 0.40 − 0.99*** − 1.85** − 3.24*** 1.38**
(0.60) (-3.78) (-2.54) (-6.70) (2.34) (0.61) (-3.82) (-2.54) (-6.66) (2.38)
l.(NIM*dHGDPCONS) 9.13** 1.00*** 11.25*** 3.12*** 8.13** / / / / /
(2.45) (2.73) (3.06) (5.41) (2.17)
l.(NIM* dLGDPCONS) 2.76** 2.60*** 5.36*** 5.20*** 0.16 / / / / /
(2.14) (3.59) (3.38) (5.01) (0.17)
l.(NIM*dHGDPRATE) / / / / / 6.32** 1.30* 9.54*** 4.53*** 5.02*
(2.03) (1.67) (2.96) (4.11) (1.69)
l.(NIM* dLGDPRATE) / / / / / 8.93** 1.08*** 11.00*** 3.16*** 7.85**
(2.46) (3.04) (3.07) (5.54) (2.14)
l.lnTA 0.052 0.038*** 0.14*** 0.13*** 0.014 0.049 0.038*** 0.14*** 0.13*** 0.011
(1.58) (2.75) (4.12) (7.06) (0.49) (1.50) (2.70) (4.11) (7.06) (0.39)
l.RWCR − 0.49*** − 0.21*** − 0.42** − 0.14*** − 0.28* − 0.47*** − 0.22*** − 0.40** − 0.15*** − 0.25*
12
(-2.83) (-5.07) (-2.50) (-3.17) (-1.73) (-2.82) (-5.17) (-2.49) (-3.53) (-1.65)
l.CREDIT_RISK 0.47 0.037 0.46 0.025 0.44 0.48 0.036 0.47 0.022 0.44
(1.41) (1.14) (1.38) (0.66) (1.35) (1.43) (1.09) (1.40) (0.58) (1.38)
l.LIQ − 0.069 − 0.068** − 0.11 − 0.10*** − 0.002 − 0.079 − 0.065** − 0.11 − 0.10*** − 0.014
(-0.94) (-2.10) (-1.40) (-2.85) (-0.028) (-1.07) (-2.08) (-1.50) (-2.83) (-0.23)
l.MP 6.09 1.71 1.09 − 3.29** 4.38 6.17 1.74 1.08 − 3.35** 4.43
(1.63) (1.43) (0.29) (-2.12) (1.27) (1.63) (1.44) (0.28) (-2.15) (1.26)

l.GDPRATE − 0.93* − 0.38* − 0.49 0.057 − 0.55 − 1.01* − 0.38* − 0.53 0.11 − 0.63
(-1.81) (-1.81) (-0.92) (0.22) (-1.19) (-1.95) (-1.78) (-0.98) (0.42) (-1.36)
Constant − 0.72* − 0.29* − 1.27*** − 0.84*** − 0.43 − 0.70* − 0.28* − 1.27*** − 0.86*** − 0.41
(-1.88) (-1.91) (-3.25) (-4.44) (-1.29) (-1.87) (-1.85) (-3.31) (-4.48) (-1.29)
Bank-fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Adj. R2 0.38 0.73 0.43 0.81 0.36 0.38 0.72 0.43 0.81 0.36
Observations 536 536 536 536 536 536 536 536 536 536
Notes: The table reports the estimation results of the impact of bank market power on liquidity creation by economic distance. We here estimate Eqs. (3) and (4). The liquidity creation dependent variable
used in column (1) to column (5) is represented by CATFAT, CATNONFAT, MATFAT, MATNONFAT and OFFLC, respectively. The explanatory variables of interest here are l.NIM, l.(NIM*dHGDPCONS), l.
(NIM*dLGDPCONS), l.(NIM*dHGDPRATE) and l.(NIM*dLGDPRATE). All regressions are estimated using the OLS method with bank-fixed effects controlled. We report t-statistics based on cluster-robust
standard errors in parenthesis. ***, **, * denote significance at one, five and ten percent levels, respectively. All variables are defined in Table 1.
M.Y. Toh and D. Jia
Table 6
Impact of bank market power on liquidity creation by institutional distance.
Panel A: Distance in economic freedom index as an institutional distance proxy Panel B: Distance in financial freedom index as an institutional distance proxy
Dependent variable CATFAT CATNONFAT MATFAT MATNONFAT OFFLC CATFAT CATNONFAT MATFAT MATNONFAT OFFLC
(1) (2) (3) (4) (5) (1) (2) (3) (4) (5)
l.NIM 0.50 − 1.00*** − 1.79** − 3.29*** 1.50** 0.40 − 1.03*** − 1.88** − 3.32*** 1.43**
(0.75) (-3.89) (-2.41) (-6.75) (2.54) (0.61) (-4.11) (-2.56) (-6.87) (2.42)
l.(NIM*dHECOFREE) 8.82** 1.08*** 10.95*** 3.22*** 7.73** / / / / /
(2.45) (3.03) (3.09) (5.61) (2.13)
l.(NIM* dLECOFREE) 6.11* 1.59 8.89*** 4.37*** 4.52 / / / / /
(1.89) (1.34) (2.58) (2.71) (1.60)
l.(NIM*dHFINFREE) / / / / / 8.78** 1.12*** 10.94*** 3.28*** 7.66**
(2.44) (3.15) (3.09) (3.70) (2.11)
l.(NIM* dLFINFREE) / / / / / 11.40*** 3.09** 13.86*** 5.55*** 8.31***
(3.21) (2.30) (3.87) (3.03) (2.61)
l.lnTA 0.060* 0.036*** 0.15*** 0.12*** 0.024 0.050 0.034** 0.14*** 0.12*** 0.016
(1.74) (2.59) (4.10) (6.77) (0.80) (1.49) (2.51) (3.94) (6.96) (0.55)
l.RWCR − 0.47*** − 0.22*** − 0.40** − 0.15*** − 0.25* − 0.46*** − 0.20*** − 0.38** − 0.12*** − 0.26
13
(-2.83) (-5.27) (-2.50) (-3.47) (-1.64) (-2.58) (-4.64) (-2.25) (-2.93) (-1.57)
l.CREDIT_RISK 0.48 0.035 0.47 0.021 0.48 0.48 0.037 0.47 0.024 0.44
(1.44) (1.08) (1.41) (0.56) (1.39) (1.43) (1.11) (1.40) (0.62) (1.37)
l.LIQ − 0.075 − 0.066** − 0.11 − 0.10*** − 0.010 − 0.077 − 0.064** − 0.11 − 0.099*** − 0.012
(-1.02) (-2.08) (-1.47) (-2.85) (-0.16) (-1.04) (-2.08) (-1.48) (-2.88) (-0.21)
l.MP 5.78 1.78 0.83 − 3.17** 4.00 5.71 1.58 0.69 − 3.43** 4.13
(1.52) (1.48) (0.22) (-2.02) (1.13) (1.53) (1.34) (0.18) (-2.19) (1.18)

l.GDPRATE − 0.86* − 0.39* − 0.44 0.033 − 0.47 − 0.87* − 0.37* − 0.44 0.070 − 0.51
(-1.67) (-1.88) (-0.81) (0.13) (-1.01) (-1.69) (-1.77) (-0.81) (0.27) (-1.09)
Constant − 0.81** − 0.27* − 1.35*** − 0.80*** − 0.54 − 0.72* − 0.25* − 1.27*** − 0.79*** − 0.47
(-2.04) (-1.77) (-3.31) (-4.26) (-1.57) (-1.87) (-1.69) (-3.20) (-4.33) (-1.39)
Bank-fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Adj. R2 0.38 0.72 0.43 0.81 0.36 0.38 0.73 0.43 0.81 0.36
Observations 536 536 536 536 536 536 536 536 536 536
Notes: The table reports the estimation results of the impact of bank market power on liquidity creation by institutional distance. We here estimate Eqs. (5) and (6). The liquidity creation dependent
variable used in column (1) to column (5) is represented by CATFAT, CATNONFAT, MATFAT, MATNONFAT and OFFLC, respectively. The explanatory variables of interest here are l.NIM, l.(NIM*d
HECOFREE), l.(NIM*dLECOFREE),l.(NIM*dHFINFREE) and l.(NIM*dLFINFREE). All regressions are estimated using the OLS method with bank-fixed effects controlled. We report t-statistics based on
cluster-robust standard errors in parenthesis. ***, **, * denote significance at one, five and ten percent levels, respectively. All variables are defined in Table 1.
M.Y. Toh and D. Jia
Table 7
Removing the 2008-2010 crisis period from estimation.
Dependent variable: CATFAT Dependent variable: MATFAT
Eq. (1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
l.NIM 0.20 0.17 0.10 0.21 0.32 0.21 − 1.42* − 1.46* − 1.52* − 1.41* − 1.32 − 1.44*
(0.32) (0.26) (0.16) (0.33) (0.50) (0.33) (-1.70) (-1.72) (-1.81) (-1.68) (-1.56) (-1.71)
l.(NIM*dFOREIGN) 10.02*** 11.33***
(2.78) (3.13)
l.(NIM*dSDIST) − 3.53 − 2.77
(-0.70) (-0.60)
l.(NIM*dLDIST) 10.27*** 11.59***
(2.84) (3.19)
l.(NIM*dHGDPCONS) 10.23*** 11.55***
(2.80) (3.15)
l.(NIM* dLGDPCONS) 1.79 2.67
(0.56) (0.74)
l.(NIM* dHGDPRATE) 6.07* 8.88**
(1.68) (2.35)
l.(NIM* dLGDPRATE) 10.13*** 11.40***
(2.83) (3.15)
l.(NIM* dHECOFREE) 10.14*** 11.43***
(2.83) (3.17)
l.(NIM* dLECOFREE) 5.61* 7.62**
(1.69) (2.07)
l.(NIM* dHFINFREE) 10.02*** 11.34***
14
(2.79) (3.13)
l.(NIM* dLFINFREE) 9.69*** 12.00***
(2.91) (3.42)
l.lnTA 0.072* 0.071* 0.063 0.066* 0.086** 0.072* 0.14*** 0.13*** 0.13*** 0.13*** 0.15*** 0.14***
(1.82) (1.79) (1.56) (1.70) (2.06) (1.77) (3.38) (3.36) (3.09) (3.31) (3.45) (3.22)
l.RWCR − 0.65*** − 0.65*** − 0.66*** − 0.63*** − 0.61*** − 0.65*** − 0.57*** − 0.58*** − 0.59*** − 0.56*** − 0.55*** − 0.57***
(-3.36) (-3.40) (-3.38) (-3.44) (-3.40) (-3.19) (-3.08) (-3.12) (-3.11) (-3.11) (-3.11) (-2.86)

l.CREDIT_RISK 0.54 0.56 0.54*** 0.54 0.56 0.54 0.49 0.52 0.49 0.50 0.51 0.49
(1.27) (1.30) (1.26) (1.29) (1.32) (1.27) (1.18) (1.22) (1.17) (1.19) (1.22) (1.17)
l.LIQ 0.016 0.035 0.021 0.016 0.023 0.017 − 0.025 − 0.006 − 0.021 − 0.026 − 0.020 − 0.026
(0.22) (0.46) (0.27) (0.22) (0.31) (0.22) (-0.34) (-0.076) (-0.27) (-0.34) (-0.26) (-0.34)
l.MP 1.70 1.43 2.44 0.68 0.85 1.68 2.94 2.66 3.73 2.30 2.22 2.98
(0.24) (0.20) (0.34) (0.094) (0.12) (0.23) (0.41) (0.37) (0.52) (0.32) (0.30) (0.41)
l.GDPRATE − 2.71*** − 2.83*** − 2.71*** − 3.13*** − 2.74*** − 2.72*** − 2.02** − 2.15** − 2.02** − 2.28** − 2.04** − 2.00**
(-2.92) (-3.03) (-2.94) (-3.21) (-2.97) (-2.90) (-2.16) (-2.28) (-2.17) (-2.33) (-2.20) (-2.12)
Constant − 0.75* − 0.70* − 0.65 − 0.63 − 0.88** − 0.76* − 1.22*** − 1.17*** − 1.12*** − 1.15*** − 1.33*** − 1.21***
(-1.79) (-1.69) (-1.58) (-1.55) (-1.98) (-1.78) (-2.84) (-2.75) (-2.64) (-2.73) (-2.91) (-2.78)
Bank-fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Adj. R2 0.41 0.41 0.41 0.41 0.41 0.41 0.44 0.44 0.44 0.44 0.44 0.44
Observations 430 430 430 430 430 430 430 430 430 430 430 430
Notes: The table reports the estimation results of the impact of bank market power on bank liquidity creation by ownership type and home-host country distance. For the sake of brevity, we report only the
results of aggregate liquidity creation (CATFAT and MATFAT). We here re-estimate Eqs. (1) to (6) after removing banks observations from 2008 to 2010 from our sample. The explanatory variables of
interest here are the one-year lagged interaction terms between NIM and a dummy variable for foreign ownership and between NIM and dummy variables for home-host country distance. All regressions
are estimated using the OLS method with bank-fixed effects controlled. We report t-statistics based on cluster-robust standard errors in parenthesis. ***, **, * denote significance at one, five and ten percent
levels, respectively. All variables are defined in Table 1.
Table 8
M.Y. Toh and D. Jia

Small banks versus large banks.
Panel A: Small banks
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
l.NIM 2.27 2.33 2.21 2.21 2.38* 2.20 − 1.52 − 1.46 − 1.53 − 1.58 − 1.44 − 1.62
(1.60) (1.63) (1.56) (1.55) (1.67) (1.53) (-0.89) (-0.84) (-0.89) (-0.91) (-0.83) (-0.94)
l.(NIM*dFOREIGN) 6.98* 10.70***
(1.80) (2.72)
l.(NIM*dSDIST) − 1.02 3.03
(-0.30) (0.84)
l.(NIM*dLDIST) 7.16* 10.87***
(1.83) (2.74)
l.(NIM*dHGDPCONS) 5.60* 10.50***
(1.65) (2.78)
l.(NIM* dLGDPCONS) 7.12* 10.72***
(1.78) (2.63)
l.(NIM* dHGDPRATE) 7.33* 11.00***
(1.82) (2.70)
l.(NIM* dLGDPRATE) 1.46 5.66**
(0.69) (2.31)
l.(NIM* dHECOFREE) 7.01* 10.72***
(1.82) (2.73)
l.(NIM* dLECOFREE) 3.64 8.23**
(1.00) (2.04)
15
l.(NIM* dHFINFREE) 7.04* 10.77***

(1.81) (2.74)
l.(NIM* dLFINFREE) 9.20** 13.59***
(2.26) (3.23)
l.lnTA 0.13 0.14* 0.12 0.12 0.14* 0.12 0.19** 0.20** 0.18** 0.18** 0.20** 0.18**
(1.61) (1.70) (1.53) (1.55) (1.74) (1.42) (2.28) (2.34) (2.28) (2.21) (2.29) (2.05)
l.RWCR − 0.33 − 0.33 − 0.33 − 0.36 − 0.31** − 0.32 − 0.31 − 0.31 − 0.31 − 0.32 − 0.29 − 0.29

(-1.61) (-1.61) (-1.62) (-1.64) (-1.55) (-1.51) (-1.51) (-1.50) (-1.50) (-1.54) (-1.46) (-1.40)
l.CREDIT_RISK 0.78 0.77 0.77 0.77 0.79 0.78 0.69 0.69 0.69 0.68 0.70 0.70
(1.29) (1.28) (1.28) (1.27) (1.31) (1.29) (1.16) (1.14) (1.16) (1.13) (1.17) (1.16)
l.LIQ − 0.068 − 0.055 − 0.068 − 0.059 − 0.065 − 0.067 − 0.084 − 0.071 − 0.083 − 0.076 − 0.081 − 0.082
(-0.84) (-0.69) (-0.84) (-0.74) (-0.81) (-0.83) (-1.06) (-0.91) (-1.05) (-0.96) (-1.03) (-1.04)
l.MP 9.58 8.85 9.83 9.98 9.17 9.19 2.73 2.03 2.76 3.09 2.42 2.21
(1.15) (1.04) (1.18) (1.21) (1.09) (1.12) (0.32) (0.24) (0.33) (0.37) (0.85) (0.27)
l.GDPRATE − 1.17 − 1.18 − 1.25 − 1.22 − 1.07 − 1.13 − 0.73 − 0.74 − 0.74 − 0.77 − 0.65 − 0.67
(-1.15) (-1.16) (-1.23) (-1.21) (-1.05) (-1.11) (-0.67) (-0.68) (-0.69) (-0.72) (-0.60) (-0.62)
Constant − 1.71*** − 1.76*** − 1.64*** − 1.66*** − 1.83*** − 1.64*** − 1.90*** − 1.94*** − 1.89*** − 1.85*** − 1.99*** − 1.81***
(-2.82) (-2.88) (-2.76) (-2.71) (-2.92) (-2.62) (-2.90) (-2.94) (-2.94) (-2.80) (-2.90) (-2.68)
Adj. R2 0.36 0.36 0.35 0.36 0.36 0.35 0.38 0.38 0.37 0.38 0.38 0.38
Observations 260 260 260 260 260 260 260 260 260 260 260 260
Panel B: Large banks
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
(continued on next page)

Table 8 (continued )
M.Y. Toh and D. Jia

Panel B: Large banks
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
l.NIM − 0.80* − 0.79* − 0.81** − 0.79* − 0.80* − 0.80* − 1.73* − 1.73* − 1.74* − 1.73* − 1.73* − 1.74*
(-1.95) (-1.87) (-1.99) (-1.87) (-1.95) (-1.95) (-1.95) (-1.94) (-1.96) (-1.94) (-1.95) (-1.95)
l.(NIM*dFOREIGN) 1.54 1.46
(0.53) (0.56)
l.(NIM*dSDIST) 2.65 1.19
(0.38) (0.16)
l.(NIM*dLDIST) 1.09 1.58
(0.36) (0.69)
l.(NIM*dHGDPCONS) − 1.17 − 0.75
(-0.39) (-0.28)
(0.44) (0.47)
l.(NIM* dHGDPRATE) 1.09 1.58
(0.36) (0.69)
l.(NIM* dLGDPRATE) 2.65 1.19
(0.38) (0.16)
l.(NIM* dHECOFREE) 1.54 1.46
(0.53) (0.56)
l.(NIM* dLECOFREE) n/a n/a
l.(NIM* dHFINFREE) 1.54 1.47
(0.53) (0.56)
16
l.(NIM* dLFINFREE) − 47.24 − 284.44***

(-0.65) (-3.48)
l.lnTA − 0.025 − 0.025 − 0.028 − 0.025 − 0.025 − 0.025 0.044* 0.044* 0.041* 0.044* 0.044* 0.043*
(-1.35) (-1.36) (-1.54) (-1.36) (-1.35) (-1.35) (1.94) (1.95) (1.83) (1.95) (1.95) (1.93)
l.RWCR 0.16 0.17 0.11 0.17 0.16 0.16 0.76** 0.76** 0.72* 0.76** 0.76** 0.77**
(0.48) (0.50) (0.34) (0.50) (0.48) (0.48) (2.00) (1.98) (1.86) (1.98) (2.00) (2.00)
l.CREDIT_RISK 0.021 0.020 0.044 0.020 0.021 0.021 0.031 0.031 0.049 0.031 0.031 0.031

(0.38) (0.35) (0.71) (0.35) (0.38) (0.38) (0.45) (0.45) (0.66) (0.45) (0.45) (0.46)
l.LIQ − 0.35*** − 0.35*** − 0.35*** − 0.35*** − 0.35*** − 0.35*** − 0.44*** − 0.43*** − 0.43*** − 0.43*** − 0.44*** − 0.43***
(-5.43) (-5.47) (-5.54) (-5.48) (-5.43) (-5.41) (-6.21) (-5.97) (-6.17) (-5.97) (-6.21) (-6.17)
l.MP 3.66** 3.71** 3.81** 3.71** 3.67** 3.66** 2.27 2.26 2.39 2.26 2.27 2.27
(2.15) (2.13) (2.25) (2.13) (2.15) (2.15) (1.13) (1.10) (1.19) (1.10) (1.13) (1.12)
l.GDPRATE − 0.56* − 0.56* − 0.67** − 0.56* − 0.56* − 0.56* − 0.33 − 0.33 − 0.42 − 0.33 − 0.33 − 0.33
(-1.77) (-1.76) (-2.11) (-1.76) (-1.77) (-1.76) (-1.00) (-0.99) (-1.24) (-0.99) (-1.00) (-0.99)
Constant 0.52** 0.52** 0.56** 0.52** 0.52** 0.52** 0.001 0.002 0.030 0.002 0.001 0.004
(2.34) (2.32) (2.50) (2.32) (2.34) (2.34) (0.005) (0.006) (0.11) (0.006) (0.005) (0.014)
Adj. R2 0.57 0.57 0.58 0.57 0.57 0.57 0.48 0.47 0.48 0.47 0.48 0.47
Observations 267 267 267 267 267 267 267 267 267 267 267 267
results of aggregate liquidity creation (CATFAT and MATFAT). We here re-estimate Eqs. (1) to (6) after splitting the sample into small banks and large banks using median real total assets (MYR 23.675
billion) as the cut-off point. Panel A reports the results for small banks, while Panel B reports the results for large banks. In column (5) of these panels, “n/a” indicates that no bank observation falls in the
foreign bank group originated from countries with poorer economic freedom than the host country, so the variable is omitted from estimations. The explanatory variables of interest here are the one-year
lagged interaction terms between NIM and a dummy variable for foreign ownership and between NIM and dummy variables for home-host country distance. All regressions are estimated using the OLS
method with bank-fixed effects controlled. We report t-statistics based on cluster-robust standard errors in parenthesis. ***, **, * denote significance at one, five and ten percent levels, respectively. All
variables are defined in Table 1.
Table 9
M.Y. Toh and D. Jia

System GMM estimation.
Eq. (1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
l.NIM − 1.36 − 1.53 − 1.47 − 1.20 − 1.40 − 1.19 − 0.088 − 0.42 − 0.53 − 0.20 0.19 0.27
(-0.79) (-0.76) (-0.72) (-0.72) (-0.76) (-0.73) (-0.08) (-0.41) (-0.49) (-0.25) (0.17) (0.27)
l.(NIM*dFOREIGN) 9.45** 7.88***
(2.65) (3.24)
l.(NIM*dSDIST) 0.84 − 1.92
(0.19) (-0.32)
l.(NIM*dLDIST) 10.29*** 8.47***
(2.71) (3.19)
l.(NIM*dHGDPCONS) 9.58*** 8.15***
(2.69) (3.04)
(1.21) (1.05)
l.(NIM* dHGDPRATE) 5.95* 5.09
(1.90) (1.30)
l.(NIM* dLGDPRATE) 9.31** 7.73***
(2.64) (2.86)
l.(NIM* dHECOFREE) 9.62** 7.32**
(2.56) (2.65)
l.(NIM* dLECOFREE) 8.65** 8.71**
(2.03) (2.10)
l.(NIM* dHFINFREE) 9.32** 7.08**
(2.47) (2.44)
17
l.(NIM* dLFINFREE) 14.87** 11.59*

(2.23) (1.87)
l.lnTA 0.056*** 0.044** 0.047** 0.044** 0.055** 0.064** 0.073*** 0.067*** 0.076*** 0.069*** 0.073*** 0.078***
(2.89) (2.04) (2.42) (2.62) (2.66) (2.60) (3.97) (2.98) (3.79) (3.81) (3.04) (2.79)
l.RWCR − 0.33* − 0.34* − 0.36* − 0.26 − 0.29 − 0.30 − 0.30* − 0.32 − 0.31* − 0.28 − 0.33* − 0.32
(-1.72) (-1.69) (-1.85) (-1.23) (-1.43) (-1.53) (-1.68) (-1.59) (-1.68) (-1.17) (-1.80) (-1.64)
l.CREDIT_RISK 0.15 0.16 0.15 0.22 0.17 0.17 0.10 0.12 0.12 0.15 0.11 0.12

(0.49) (0.51) (0.77) (0.75) (0.52) (0.50) (0.35) (0.33) (0.40) (0.51) (0.32) (0.30)
l.LIQ 0.041 − 0.022 0.005 0.004 0.022 0.035 − 0.033 − 0.097 − 0.041 − 0.063 − 0.022 − 0.023
(0.53) (-0.29) (0.10) (0.06) (0.30) (0.50) (-0.59) (-1.52) (-0.64) (-1.07) (-0.29) (-0.29)
l.MP 5.13 4.70 4.89 5.47 4.88 3.27 2.13 1.17 1.42 1.23 1.39 1.37
(1.08) (1.24) (1.16) (1.25) (1.19) (0.73) (0.52) (0.26) (0.31) (0.31) (0.46) (0.44)
l.GDPRATE − 0.56* − 0.63** − 0.58** − 0.66** − 0.52* − 0.41 − 0.43 − 0.42 − 0.41 − 0.43 − 0.44 − 0.42
(-1.82) (-2.17) (-1.99) (-2.35) (-1.93) (-1.40) (-1.46) (-1.44) (-1.41) (-1.50) (-1.50) (-1.29)
l.dependent variable 0.31*** 0.28*** 0.29*** 0.29*** 0.31*** 0.30*** 0.32*** 0.30** 0.32*** 0.32*** 0.33*** 0.33***
(3.33) (2.74) (3.18) (3.12) (3.16) (3.13) (3.33) (2.62) (3.19) (3.11) (3.33) (3.08)
Constant − 0.66* − 0.47 − 0.52** − 0.58* − 0.66* − 0.72* − 0.61* − 0.45 − 0.60 − 0.53 − 0.60 − 0.65
(-1.71) (-1.41) (-2.36) (-1.89) (-1.78) (-1.76) (-1.76) (-1.27) (-1.55) (-1.61) (-1.32) (-1.29)
AR2 (p-value) 0.25 0.25 0.26 0.27 0.26 0.25 0.24 0.23 0.24 0.24 0.23 0.23
Hansen test (p-value) 0.83 0.99 0.99 0.99 0.99 0.97 0.82 0.99 0.99 0.99 1.00 0.97
Observations 536 536 536 536 536 536 536 536 536 536 536 536
Notes: The table reports the GMM estimation results of the impact of bank market power on bank liquidity creation by ownership type and home-host country distance. For the sake of brevity, we report
only the results of aggregate liquidity creation (CATFAT and MATFAT). We here re-estimate Eqs. (1) to (6) after adding a lagged dependent variable into the equations. The explanatory variables of interest
here are the one-year lagged interaction terms between NIM and a dummy variable for foreign ownership and between NIM and dummy variables for home-host country distance. All regressions are
estimated using the two-step system GMM estimator. Hansen test is a test of the over-identifying restrictions under the null hypothesis of joint validity of instruments. AR2 test is a test of the absence of
second order residual autocorrelation. We report t-statistics based on Windmeijer’s (2005) standard errors in parenthesis. ***, **, * denote significance at one, five and ten percent levels, respectively. All
variables are defined in Table 1.
M.Y. Toh and D. Jia
Table 10
Adding a dummy variable for Islamic banks.
Eq. (1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
l.NIM − 0.72** − 0.33 − 0.61* − 0.75** − 0.70** − 0.68* − 0.99*(-1.73) − 0.84 − 1.07* − 1.09* − 1.02* − 1.00*
(-2.04) (-0.94) (-1.75) (-2.17) (-1.97) (-1.90) (-1.38) (-1.82) (-1.95) (-1.78) (-1.75)
l.(NIM*dFOREIGN) 3.61*** 2.85***
(10.95) (7.07)
l.(NIM*dSDIST) 3.40*** 1.53**
(6.26) (2.27)
l.(NIM*dLDIST) 3.29*** 2.94***
(9.35) (7.34)
l.(NIM*dHGDPCONS) 3.74*** 3.37***
(9.14) (7.10)
l.(NIM* dLGDPCONS) 2.68*** 0.14
(7.87) (0.28)
l.(NIM* dHGDPRATE) 3.13*** 1.97***
(8..03) (3.37)
l.(NIM* dLGDPRATE) 3.75*** 3.05***
(9.62) (6.99)
l.(NIM* dHECOFREE) 3.59*** 2.90***
(10.03) (7.01)
l.(NIM* dLECOFREE) 4.10*** 2.68***
(6.55) (3.45)
l.(NIM* dHFINFREE) 3.58*** 2.86***
18
(10.39) (6.96)
l.(NIM* dLFINFREE) 8.15*** 6.40***
(5.06) (4.69)
l.lnTA − 0.008 − 0.008 − 0.006 − 0.008 − 0.006 − 0.004 0.040*** 0.037*** 0.045*** 0.039*** 0.041*** 0.045***
(-1.38) (-1.49) (-1.14) (-1.48) (-1.12) (-0.73) (6.06) (6.07) (6.53) (5.97) (5.83) (6.49)
l.RWCR − 0.25*** − 0.23*** − 0.24*** − 0.24*** − 0.25*** − 0.25*** − 0.19*** − 0.14** − 0.18*** − 0.19*** − 0.19*** − 0.17***
(-3.31) (-3.36) (-3.29) (-3.16) (-3.39) (-3.53) (-3.02) (-2.26) (-2.71) (-2.88) (-3.01) (-2.87)

l.CREDIT_RISK 0.20*** 0.21*** 0.19*** 0.20*** 0.20*** 0.21 0.14*** 0.14*** 0.13** 0.15*** 0.14** 0.15***
(4.14) (4.90) (4.26) (4.16) (4.11) (0.40) (2.62) (3.03) (2.39) (2.68) (2.54) (2.72)
l.LIQ − 0.17*** − 0.24*** − 0.18*** − 0.18*** − 0.16*** − 0.16*** − 0.32*** − 0.41*** − 0.33*** − 0.32*** − 0.31*** − 0.31***
(-4.11) (-7.34) (-4.24) (-4.21) (-3.93) (-3.78) (-6.34) (-10.13) (-6.44) (-6.46) (-6.19) (-6.07)
l.MP 0.71 1.52 0.86 0.70 0.71 0.59 − 0.52 0.25 − 0.85 − 0.58 − 0.47 − 0.68
(0.49) (1.04) (0.58) (0.49) (0.49) (0.40) (-0.30) (0.15) (-0.47) (-0.34) (-0.27) (-0.39)
l.GDPRATE − 0.37 − 0.58** − 0.37 − 0.38 − 0.38 − 0.37 − 0.15 − 0.27 − 0.12 − 0.17 − 0.14 − 0.13
(-1.58) (-2.53) (-1.48) (-1.63) (-1.58) (-1.52) (-0.53) (-1.06) (-0.42) (-0.62) (-0.49) (-0.45)
ISB − 0.12*** − 0.12*** − 0.12*** − 0.12*** − 0.12*** − 0.12*** 0.054** 0.03 0.058*** 0.058*** 0.055*** 0.060***
(-8.90) (-9.39) (-8.80) (-8.65) (-8.89) (-8.81) (2.56) (1.42) (2.70) (2.80) (2.69) (2.90)
Constant 0.31*** 0.30*** 0.29*** 0.31*** 0.29*** 0.26*** 0.079 0.11 0.041 0.092 0.076 0.021
(3.48) (3.65) (3.29) (3.55) (3.30) (2.89) (0.76) (1.23) (0.38) (0.89) (0.71) (0.20)
Adj. R2 0.44 0.47 0.42 0.44 0.44 0.44 0.40 0.43 0.41 0.40 0.40 0.41
Observations 536 536 536 536 536 536 536 536 536 536 536 536
results of aggregate liquidity creation (CATFAT and MATFAT). We here re-estimate Eqs. (1) to (6) after adding a dummy variable for Islamic banks (IBS) in the equations. The explanatory variables of
interest here are the one-year lagged interaction terms between NIM and a dummy variable for foreign ownership and between NIM and dummy variables for home-host country distance. All regressions
are estimated using the OLS method without bank-fixed effects controlled. We report t-statistics based on cluster-robust standard errors in parenthesis. ***, **, * denote significance at one, five and ten
percent levels, respectively. All variables are defined in Table 1.
M.Y. Toh and D. Jia
Table 11
Using LERNER as the alternative bank market power measure.
Eq. (1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)
l.LERNER − 0.13** − 0.13*** − 0.12*** − 0.14*** − 0.13*** − 0.13*** − 0.035 − 0.034 − 0.031 − 0.047 − 0.062 − 0.040
(-3.85) (-3.91) (-3.61) (-4.02) (-3.44) (-3.78) (-0.89) (-0.87) (-0.81) (-1.26) (-1.55) (-1.04)
l.(LERNER*dFOREIGN) 0.18*** 0.13***
(4.08) (2.86)
l.(LERNER*dSDIST) 0.32*** 0.089
(4.12) (1.05)
l.(LERNER*dLDIST) 0.16*** 0.14***
(3.48) (2.88)
l.(LERNER *dHGDPCONS) 0.12*** 0.10**
(2.73) (2.09)
l.(LERNER* dLGDPCONS) 0.43*** 0.24**
(5.90) (2.58)
l.(LERNER* dHGDPRATE) 0.18** 0.24***
(2.47) (2.62)
l.(LERNER* dLGDPRATE) 0.15*** 0.037
(2.96) (0.71)
l.(LERNER* dHECOFREE) 0.17*** 0.099**
(3.47) (2.12)
l.(LERNER* dLECOFREE) 0.21 0.59***
(1.45) (2.97)
l.(LERNER* dHFINFREE) 0.16*** 0.12***
19
(3.64) (2.76)
l.(LERNER* dLFINFREE) 0.43* 0.66**
(1.78) (2.18)
l.lnTA − 0.023*** − 0.022*** − 0.024*** − 0.024*** − 0.021*** − 0.020*** 0.016*** 0.016*** 0.015*** 0.015*** 0.021*** 0.024***
(-4.21) (-3.92) (-4.36) (-4.23) (-3.77) (-3.69) (2.84) (2.79) (2.64) (2.70) (3.75) (4.09)
l.RWCR − 0.16*** − 0.16*** − 0.16*** − 0.18*** − 0.16*** − 0.16*** − 0.20*** − 0.20** − 0.21*** − 0.22*** − 0.21*** − 0.19***
(-4.22) (-4.19) (-4.34) (-4.25) (-3.91) (-4.14) (-4.39) (-4.36) (-4.42) (-4.79) (-4.31) (-4.03)

l.CREDIT_RISK 0.17*** 0.18*** 0.19*** 0.18*** 0.19*** 0.19*** 0.086** 0.084* 0.093** 0.081* 0.081* 0.089**
(4.45) (4.58) (4.94) (4.43) (4.49) (4.57) (1.98) (1.93) (2.11) (1.82) (1.82) (1.97)
l.LIQ − 0.21*** − 0.20*** − 0.20*** − 0.19*** − 0.20*** − 0.20*** − 0.34*** − 0.34*** − 0.33*** − 0.31*** − 0.34*** − 0.34***
(-5.51) (-5.34) (-5.31) (-4.90) (-4.99) (-5.03) (-8.03) (-8.03) (-7.82) (-7.22) (-7.48) (-7.38)
l.MP 1.79 1.71 1.98 1.40 1.48 1.44 0.064 0.047 0.15 − 0.49 − 0.23(-0.15) − 0.25
(1.15) (1.11) (1.30) (0.88) (0.90) (0.89) (0.043) (0.031) (0.10) (-0.32) (-0.16)
l.GDPRATE − 0.41 − 0.40 − 0.42* − 0.34 − 0.35 − 0.35 0.0007 0.0004 − 0.00003 0.13 0.039 0.018
(-1.58) (-1.55) (-1.66) (-1.30) (-1.27) (-1.28) (0.003) (0.001) (-0.0001) (0.46) (0.14) (0.060)
ISB − 0.14*** − 0.14*** − 0.14*** − 0.14*** − 0.13*** − 0.13*** − 0.008 − 0.008 − 0.010 − 0.009 0.003 0.006
(-10.54) (-10.35) (-10.90) (-10.1) (-9.86) (-10.17) (-0.49) (-0.51) (-0.58) (-0.51) (0.20) (0.38)
Constant 0.49*** 0.47*** 0.48*** 0.50*** 0.46*** 0.49*** 0.37*** 0.38*** 0.37*** 0.39*** 0.33*** 0.29***
(5.90) (5.56) (5.88) (5.72) (5.38) (5.37) (4.53) (4.56) (4.51) (4.76) (3.97) (3.50)
Adj. R2 0.37 0.37 0.38 0.34 0.34 0.36 0.38 0.38 0.38 0.39 0.37 0.37
Observations 536 536 536 536 536 536 536 536 536 536 536 536
results of aggregate liquidity creation (CATFAT and MATFAT). We here re-estimate Eqs. (1) to (6) after replacing NIM by LERNER and adding a dummy variable for Islamic banks (IBS) in the equations. The
explanatory variables of interest here are the one-year lagged interaction terms between NIM and a dummy variable for foreign ownership and between NIM and dummy variables for home-host country
distance. All regressions are estimated using the OLS method without bank-fixed effects controlled. We report t-statistics based on cluster-robust standard errors in parenthesis. ***, **, * denote sig
nificance at one, five and ten percent levels, respectively. All variables are defined in Table 1.
4.4. Robustness tests
Numerous robustness tests are performed, including removing the 2008–2010 crisis period from model estimations, splitting the
sample by banks size, using two alternative estimation methods and an alternative bank market power measure. The results of these
robustness tests are provided in Tables 7–11. In each table, we report only the results for CATFAT and MATFAT aggregate liquidity
creation measures for the sake of brevity, and for each of these measures, the regression Eqs. (1) to (6) are re-estimated and reported
accordingly.2
4.4.1. Removing 2008–2010 crisis period

One may be concerned that the financial market and monetary liquidity squeezes happened in some Western countries during the
2008 global financial crisis might have spill-over effects to Eastern countries and their banking sectors. To ensure the crisis does not
contaminate our empirical results, we remove bank observations over the years 2008–2010 and re-estimate Eqs. (1) to (6)3 . Based on
the results reported in Table 7, the coefficients on the interaction terms between NIM and a dummy variable for foreign ownership and
between NIM and dummy variables for home-host country distance are generally positive and statistically significant, irrespective of
CATFAT and MATFAT liquidity creation measures. We thereby affirm our main findings that foreign banks create more liquidity for the
local market than domestic banks for a similar level of increase in market power and that home-host country distance in culture,
economic development and institution is the factor driving to the positive impact of bank market power on liquidity creation of foreign
banks in the host country.
4.4.2. Splitting study sample by bank size

The Malaysian banking market is highly concentrated, with almost 43 % asset market share dominated by three largest domestic
banks at the end-year 2017, leaving the remaining 56 % shared by forty one domestic and foreign banks. The highly uneven distri
bution of bank market share reveals that smaller banks face greater competitive pressure than large banks as they have lower franchise
value and could be easily eliminated through competition. Large bank size offers the possibility of realizing economies of scale and
scope for offering a diversified range of product lines for various market segments ranging from households, retail to corporate through
extensive branch networks (Akhavein et al., 2005; Petersen and Rajan, 2002; Vives, 2001). Thus, large banks are always at the frontier
of technology innovation and adoption and rely more on lending technologies based on hard information which can be applied in a
standardized manner at all branches for customers at arm’s length. Small banks, on the other hand, tap in the market by offering
specialized financial solutions for customers and making exclusive relationships with them, (Cole et al., 2004; Stein, 2002). Small
banks lend at a shorter physical distance from their customers to facilitate information collection and relationship management
(Berger et al., 2005).
Considering the operational differences between small banks and large banks, it might be interesting to find out whether the main
results hold for banks of difference size classes, that is, whether small (large) domestic banks respond differently from small (large)
foreign banks. In the second robustness test, we classify banks into small and large banks using the median of banks’ total assets (MYR
23.675 billion) as the cut-off point. In the small bank group, there are 59 domestic bank observations and 201 foreign bank obser
vations; whereas, in the large bank group, there are 186 domestic bank observations and 81 foreign bank observations. Such division
structure reveals that most foreign banks in Malaysia are considerably small, while most domestic banks are of large size. We re-
estimate Eqs. (1) to (6) for small and large bank groups and report the results in Panels A and B of Table 8, respectively.
In Panel A of Table 8, the estimated coefficient on l.NIM is passive in CATFAT regression and negative for MATFAT regression, but is
insignificant in almost all the regression. This result indicates that aggregate liquidity creation of small domestic banks is not
significantly affected by their market power. Recalling our earlier result that market power has a significantly negative effect on the
liquidity creation of domestic banks in some regressions in Tables 3–6, this new result suggests that any potential comparative dis
advantages of small banks can be mitigated by “home-field advantages” of being a domestic bank. Further, the coefficient on l.
(NIM*dFOREIGN) in column (1) of Table 8 Panel A is positive and statistically significant, which shows that small foreign banks
respond in their liquidity creation to a rise in market power more positively than small domestic banks. This result, again, confirms
Hypothesis 1. Looking closer at the influence of home-host country distance on small foreign banks, we first note that the coefficient on
l.(NIM*dSDIST) is statistically insignificant and that the coefficient on l.(NIM*dLDIST) is positive and significant, which suggest that
small foreign banks originated from countries with cultural proximity to the host country do not behave differently from domestic
banks in the relation between market power and liquidity creation, while small foreign banks which are cultural distant deem a rise in
market power more important to enhance their liquidity creation performance. Hypothesis 2 is again supported. Columns (3) and (4) of
Table 8 Panel A show that the coefficients on l.(NIM*dHGDPCONS), l.(NIM* dLGDPCONS), l.(NIM* dHGDPRATE) and l.(NIM*
dLGDPRATE) are positive and statistically significant. The results offer evidence supporting Hypothesis 3 that small foreign banks from
countries with economic distance to the host country tend to create more liquidity than their domestic counterparts as their market
power rises, regardless their home countries have high or lower GDP value and GDP growth rate than the host country. Similar findings
are also documented for institutional distance, as the coefficients on l.(NIM* dHECOFREE), l.(NIM* dLECOFREE), l.(NIM* dHFINFREE)
2
The results for other liquidity creation measures remain broadly unchanged and are available upon request.
3
We also perform regression estimations for Eqs. (1) to (6) during the 2008− 2010 crisis period and find that most explanatory variables of the
study interest do not exert statistically significant impact on bank liquidity creation. This suggests that banks in Malaysia behave steadily during the
period. The results of this additional test are available upon request.
20
and l.(NIM* dLFINFREE) are significantly positive. Hypothesis 4 that institutional distance drives the positive impact of market power
on the liquidity creation of foreign banks is confirmed.
Panel B of Table 8 presents the estimation results for large banks. We first note that coefficient on l.NIM is negative and statistically
significant in all the regressions, which suggests that large domestic banks are likely to cut down liquidity creation when they possess
greater market power. Along with having home-field advantages, the specialisation in hard lending technologies and the strong ca
pacity of large domestic banks, for example, extensive branch networks and delivery channels, technology diffusion and high repu
tation, provide flexibility for the banks to exploit their market power by charging higher prices on their products, while restraining
liquidity made available for private sectors, especially firms in fringe market segments. Further, we note that large foreign banks do not
react differently from their domestic counterparts in this regard, as indicated by the statistically insignificant coefficients on the lagged
interactive terms between NIM and dummy variables for foreign ownership and home-host country distance across columns (2) to (6).
This new evidence indicates that, by gaining scale and its associated economies, foreign banks can in fact overcome the challenges
associated with cultural, economic and institutional differences between home and host countries. Therefore, a rise in market power is
less crucial for large foreign banks than small foreign banks in enhancing their liquidity creation performance in the host country.
4.4.3. GMM estimation

In all the regression estimations thus far, we employ one-year lagged explanatory variables to alleviate potential simultaneity bias.
However, one may still argue that past observations of explanatory variables are not completely independent of past bank liquidity
creation, and neglecting such simultaneity may render serious consequences for inference. To further alleviate simultaneity bias, in
this robustness test, we add a one-year lagged liquidity creation variable in Eqs. (1) to (6) and estimate the dynamic models using the
two-step system Generalized Method of Moments (GMM) proposed by Arellano and Bover (1995) and Blundell and Bond (1998). GMM
estimator is the most convenient method of dealing with endogeneity issue because it is capable of generating valid internal in
struments within the panel itself for possibly endogenous variables in the model. In our case, combinations of past values of
explanatory variables and bank liquidity creation can be used as internal instruments for current realizations of bank liquidity creation.
The consistency of GMM estimation can be assessed using the Hansen test of over-identifying restrictions under the null hypothesis of
joint validity of instruments and the second-order autoregressive (AR2) test under the null hypothesis of absence of second order
autocorrelation in the error terms in both the difference regression and the system difference-level regression. The null hypotheses of
these two tests should not be rejected for the GMM estimation to be consistent. We also adopt Windmeijer’s (2005) standard error
correction method to address possible heteroscedasticity and autocorrelation issues. The results based on GMM estimation are pro
vided in Table 9. We note that the p-values corresponding to the Hansen test of over-identifying restrictions and the autoregressive
(AR2) test are greater than the ten percent significance level, indicating the consistency of the GMM estimation results. We also note
that the coefficients on the lagged interaction terms between NIM and a dummy variable for foreign ownership and between NIM and
dummy variables for home-host country distance are generally positive and statistically significant, which reaffirm our main results.
4.4.4. Inclusion of a dummy variable for Islamic banks

The Malaysian banking sector is also well known as a dual conventional and Islamic banking sector in which Islamic banks face
additional regulation accorded to Sharia principles which promote equity, participation and ownership4 . Among Sharia principles,
ijarah (leasing), mudharabah (profit sharing), musyarakah (partnership) are main principles guiding the banks’ financing decisions
and differentiating the banks from conventional commercial banks. These principles set a higher quality standard for financing
transactions of Islamic banks and are often proclaimed to alleviate adverse selection and moral hazard problems prevailing in the
banking sector (Abedifar, Molyneux and Tarazi, 2013). Nonetheless, the “islamicity” of Islamic banks in practices is also often
questioned as some studies have reported that Islamic banks are merely imitations of conventional banks with little adaption to Sharia
principles (Azmat et al., 2015; Chong and Liu, 2009; Sun et al., 2017). For example, Chong and Liu (2009) report that Islamic banks in
Malaysia are not intuitively interest free as the banks tend to benchmark against the interest rates set by the more established con
ventional banking industry in the pricing of their products. Thus, it may be interesting to find out whether Islamic banks in Malaysia
perform differently in liquidity creation from their conventional counterparts.
In our study sample, there are 17 Islamic banks. We introduce a dummy variable for Islamic banks (ISB) in Eqs. (1) to (6) and
remove bank-fixed effects (Fi) in turn because ISB is also a bank-fixed effect variable. Inclusion of both ISB and Fi will lead to mul
ticollinearity. The results of this additional test are reported in Table 10. We note that the aggregate liquidity creation of Islamic banks
is sensitive to the measurement of liquidity creation, as indicated by the negative coefficient on ISB for CATFAT and the positive
coefficient on ISB for MATFAT. To enhance the credibility of our conclusion made, we resort to the argument made by Berger and
Bouwman (2009) that CATFAT provides a more precise bank liquidity creation approximation than MATFAT because, in practice,
banks create liquidity for the economy mainly through a liquidity transformation mechanism, rather than through maturity trans
formation. For instance, a 10-year residential mortgage is more liquid than a 10-year commercial loan from the bank’s point of view
because the residential mortgage can be securitized and sold easily to the secondary bond market via the national securitization house
of Malaysia, Cagamas. Similarly, term deposits maturing within six months are treated as liquid liabilities of banks in MATFAT
measurement, yet they are not as liquid as transaction or savings deposits because a penalty can be imposed on early withdrawal of
4
Driven mainly by the supportive initiatives for Islamic finance under the Financial Sector Masterplan 2001− 2010 and the Financial Sector
Blueprint 2011− 2020, the Islamic banking assets of Malaysia have grown at an average rate of 20 percent annually over the period 2001− 2017 and
currently occupy about one quarter of the total banking market share in the country.
21
term deposits regardless of their maturity. Hinging on the limitations of MATFAT, we focus on the results of CATFAT regressions and
assert that Islamic banks in Malaysia perform less liquidity creation than their conventional counterparts. In fact, this finding is also
affirmed by the negative and statistically significant coefficient on ISB reported in Table 10 for the subsequent robustness test. We offer
two explanations for this finding. First, governed by the Sharia principles such as the profit-loss sharing (PLS) system, Islamic banks are
more conservative when making financing decisions because they must face the risk of loss and volatility of profits of financing
transactions. Islamic banks are forbidden from charging fixed rates of return on customers as generally practiced by conventional
commercial banks. Out of prudence concerns, Islamic banks are likely to contribute less liquidity creation for the private sectors than
their conventional counterparts. The second explanation could be that the market share of Islamic banks (about 25 percent) in
Malaysia is relatively smaller than that of conventional commercial banks (about 75 percent), so Islamic banks intuitively contribute
less liquidity for the economy. More importantly, based on the results in Table 10, we find that the results about the impact of market
power on the liquidity creation of foreign banks vis-à-vis domestic banks and the influence of home-host country distance remain
broadly unchanged.
4.4.5. Lerner index as an alternative measure of bank market power

In the last robustness test, we use the Lerner index as the alternative measure of bank market power. The Lerner index measures the
exercised pricing power of the bank to mark up the price over the marginal cost of its output (Lerner, 1934). The computation pro
cedure of the Lerner index is provided in Appendix C. Eqs. (1) to (6) are re-estimated using this alternative variable in place of NIM. We
report the results in Table 11 and find that our main results remain qualitatively unchanged. We thereby conclude that market power
affects bank liquidity creation more positively for foreign banks than for domestic banks, and such a positive impact is driven by home-
host country distance in culture, economic development and institution.
5. Conclusion
Since the creation of WTO in 1995, banks in developing Southeast Asian countries have experienced increasingly competitive
pressure arising from financial liberalization, deregulation and foreign bank penetration. All banks - whether domestic or foreign -
mainly rely on liquidity creation activities such as lending, deposit-taking, security trading for profits. Their ability to do so depends on
many factors. This paper places emphasis on the impact of bank market power on liquidity creation and examines whether the liquidity
creation of foreign banks responds to market power differently from domestic banks and how home-host country distance plays a role
in the impact. We select Malaysia as the study context mainly due to its liberalized, large and deep banking sector as compared to its
Southeast Asian peers.
A main result of this paper is that the impact of bank market power on bank liquidity creation is either significantly negative or
insignificant for domestic banks and is significantly positive for foreign banks operating in Malaysia. These results reflect home-field
advantages of being a domestic bank and a lack of competitive advantages of foreign banks in overcoming operational barriers in the
host country. Some degree of market power is particularly crucial for foreign banks to attract and capture customers in the host
country. Without market power, foreign banks are finding themselves increasingly marginalized from the mainstream of liquidity
creation business dominated by domestic banks which are more tolerant to a drop of market power. Furthermore, this paper finds that
cultural, economic and institutional distance between home and host countries is a key factor driving the positive impact of market
power on liquidity creation of foreign banks. As foreign banks may lose some incumbent competitive advantages in an effort of ac
commodating variant investment standards in host countries, foreign banks deem a rise of market power crucial to support their
operation in host countries. Our main results survive all the robustness tests. In particular, one of the robustness tests further show that
the influence of home-host country distance is more evident for small foreign banks which have lower franchise value than other
competitors. This result highlights the importance of having scale in the banking sector.
Our results offer several important implications for bank regulators and managers. For regulators, greater regulatory leeway and
protection could be provided for foreign banks when designing competition policies for a concentrated banking sector dominated by
large domestic banks. Regulators introduce foreign competition to local banking sectors for good purposes, such as enhanced effi
ciency, service quality and innovation. However, owing to the specificities of banking, such as financial fragility and presence of
information asymmetry, and the cross-border barriers faced by foreign banks in a host country, competition policies may be coun
teractive as it hurts the market power and liquidity creation role of not only foreign banks, but also domestic banks. Upon entry of a
foreign bank, regulators should provide headroom for the foreign bank to build up its competitive advantages, which could help in
deterring heavyweight banks from abusing their market dominance in a way that the foreign bank cannot. Inconsiderate competition
policies can lead to an imbalanced development of the banking industry in the long term as the liquidity creation performance of
foreign banks may not be sustainable in the competitive financial landscape. Foreign banks may simply shy away from competing with
domestic banks in liquidity creation market and target other business areas such as foreign exchange and private banking. As regards to
managerial implications, foreign bank managers should put emphasis on creating new sources of income and market power as an
avenue of strengthening their competitive advantages. Foreign banks’ competitive position is not as compelling as domestic banks
because customers often seek financial solutions offered by banks which have a safe and steady brand name and a sustainable business
in the country. Hence, it is important for foreign banks to build scale, implement appropriate technological and value-added solutions
and adapt their branding strategies and business models to weather the fierce competition emanated from other rivals, unless their
shareholders are in for a long game of low margins to pursue other meaningful business objectives. This paper opens up new avenues
for future research. We show that the impact of bank market power on bank liquidity creation may not always be homogenous across
the board. Other factor that may play part in the impact is worth further exploration by future studies.
22
CRediT authorship contribution statement
Moau Yong Toh: Conceptualization, Methodology, Software, Formal analysis, Investigation, Writing - original draft, Writing -
review & editing. Dekui Jia: Conceptualization, Methodology, Validation, Writing - review & editing.
Appendix A. List of sample banks by ownership type
Domestic banks Locally-incorporated foreign banks
Affin Bank Bank of America Malaysia

Alliance Bank Malaysia Bank of China (Malaysia)
AmBank Bank of Tokyo-Mitsubishi UFJ (Malaysia)
CIMB Bank BNP Paribas Malaysia
Hong Leong Bank Citibank Berhad
Malayan Banking Deutsche Bank (Malaysia)
Public Bank HSBC Bank Malaysia
RHB Bank India International Bank Malaysia
Bank Islam Malaysia Berhad Industrial and Commercial Bank of China (Malaysia)
Bank Muamalat Malaysia Berhad J.P. Morgan Chase Bank
Affin Islamic Bank Berhad Mizuho Bank (Malaysia)
Alliance Islamic Bank Berhad National Bank of Abu Dhabi
AmIslamic Bank Berhad Al Rajhi Banking & Investment Corporation (Malaysia) Berhad
CIMB Islamic Bank Berhad HSBC Amanah Malaysia Berhad
Hong Leong Islamic Bank Berhad Sumitomo Mitsui Banking Corporation Malaysia
Asian Finance Bank Berhad Bank of Nova Scotia
Maybank Islamic Berhad Royal Bank of Scotland (ceased operation from 16 December 2016)
Public Islamic Bank Berhad Standard Chartered Bank Malaysia
RHB Islamic Bank Berhad Standard Chartered Saadiq Berhad
EONCAP Islamic Bank Berhad (ceased operation in 2010) Kuwait Finance House (Malaysia) Berhad
Southern Bank Berhad (ceased operation in 2006) Bangkok Bank
OCBC Bank (Malaysia)
United Overseas Bank (Malaysia)
OCBC Al-Amin Bank Berhad
Appendix B. Classification of bank activities as liquid, semi-liquid or illiquid based on category (Cat) or maturity (Mat)
information
Assets
1 Semi-liquid (weight = 0) 1
Illiquid (weight = ) Liquid (weight = − )
2 2
Cat Cat
Commercial, industrial and business loans Consumer/retail loans
Other loans Residential mortgage loans
Property, plant and equipment Interbank loans
Investment in subsidiaries, joint ventures and Loans to governments and statutory bodies
associates
Intangible assets Cat / Mat
Deferred taxation Cash and short-term funds
Other non-current assets Deposits and placements with banks and
Mat other financial institutions
Loans, advances and financing with a remaining Securities
maturity of more than one year Derivative assets at fair value
Property, plant and equipment Mat
Investment in subsidiaries, joint ventures and Loans, advances and financing with a remaining
associates maturity of less than one year
Intangible assets
Deferred taxation
Other non-current assets
Liabilities and equity
Liquid (weight = ) Illiquid (weight = − )
2 2
Cat Cat Cat
Transaction deposits All term deposits Subordinated debts
Saving deposits Other deposits Bonds and debentures
Money market deposits Repos
(continued on next page)
23
(continued )
Liabilities and equity
Liquid (weight = ) Illiquid (weight = − )
2 2
Deposits from banks Other non-current liabilities
Derivative liabilities at fair value Equity
Mat Mat Mat
Term deposits maturing within six Term deposits with a remaining maturity of between six Term deposits with a remaining maturity of more
months months and one year than one year
Transaction deposits Repos Subordinated debts
Saving deposits Bonds and debentures
Money market deposits Other non-current liabilities
Deposits from banks Equity
Derivative liabilities at fair value
Off-balance sheet items
Illiquid (weight = ) Liquid (weight = − )
2 2
Cat / Mat Cat / Mat N/A
Direct credit substitutes Unconditionally cancellable credit commitments
Standby letters of credit
Unutilized credit card lines
Forward purchase commitments
Contingent liabilities
Appendix C. Computation of the Lerner index
The Lerner index can be mathematically expressed as:

LERNERit = Pit − PMC
it
it
(A.1) Pit is the average price of bank output, as measured by total revenues divided by total assets for bank i in
year t, and MCit is the marginal cost of bank output for bank i in year t. To calculate MC, we use a standard translog cost function of one
output, three input prices and time trend, following Hainz et al. (2013), Horvath et al. (2016), Toh (2019) and Turk-Ariss (2010). After
imposing linear homogeneity restriction and symmetry restrictions on input prices, the translog cost function is expressed as follows:
1 ∑3
1∑ 3 ∑ 3 ∑3
lnTCit = α0i + α1lnQit + α2(lnQit )2 + βj lnwjit + γjk lnwjit lnwkit + δjq lnwjit lnQit + λ1 Trendt
2 j=1
2 j=1 k=1 j=1
(A.2)
1 ∑3
+ λ2 Trendt2 + λ3 TrendtlnQit + πj Trendtlnwjit + eit
2 j=1
where lnTCit is the translog total operating costs of bank i in year t. Qit is the bank total output proxied by total assets. wjit represents the
input prices of deposits, fixed capital and labour of bank i in year t. Input price of deposits is measured as the ratio of interest expenses
to total deposits. Input price of fixed capital is measured as the ratio of operating and administrative expenses (excluding personnel
expenses) to total fixed assets. Input price of labour is measured as the ratio of personnel expenses to total assets. Trendt is the time
trend that captures technological development. eit is the idiosyncratic error term, and α, β, γ, δ, λ and π are coefficients to be estimated
using a fixed-effect estimator. The marginal cost for each bank-year observation is then calculated by taking the first derivative of the
translog cost function with respect to Q, as follows:
d(lnTCit ) TCit [ ]
MCit = = α1 + α2 lnQit + δ1q lnw1it + δ2q lnw2it + δ3q lnw3it + λ3 Trendt (A.3)
d(Qit ) Qit
where coefficients α1, α2, δ1q, δ2q, δ3q and λ3 are estimated from Eq. (A.2).
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