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The recent global financial turmoil demonstrates that illiquidity can dramatically affect macroeconomic stability. Using the three-step approach developed by Berger and Bouwman (2009) we calculate liquidity creation for a large sample of commercial banks in 14 Asia-Pacific economies from 2005 to 2010. We find that banks in this region created $7.05 trillion in liquidity in 2010 using our preferred fat liquidity creation measure, or approximately 3 times the total liquidity created in 2005. During the entire sample period, their annual average liquidity creation is $3.94 trillion, which equals 31% of their total assets. Interestingly but not surprisingly, banks only created approximately 22% of their liquidity off the balance sheet on average. Large banks and those based in Developing Asia (including China, India, Indonesia, Malaysia, Pakistan, Philippines, Sri Lanka, and Thailand) created the highest liquidity. Employing a simultaneous equations framework, we also investigate the bi-causal relationship between liquidity creation and regulatory capital. In general, our empirical results suggest a significant and negative bi-causal relationship between liquidity creation and regulatory capital for all of the sample banks. However, such a relationship varies by bank size and regions. The results find that the trade-off between the benefits of financial stability induced by enhanced capital requirements and those of higher liquidity creation is only applicable to small banks and banks located in Developing Asia. In addition, large banks and those from Industrialized Asia (including Australia and Japan) and the Newly Industrialized Economies (including Hong Kong, South Korea, Singapore, and Taiwan) decrease their regulatory capital when they create more liquidity.
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