The effect of bank liquidity creation on performance and stock returns: Evidence from Thailand

Abstract

This study investigates the relationship between bank liquidity creation, performance, and stock returns across 11 banks in Thailand from 2012 to 2021, spanning the economic crisis in Thailand and the COVID-19 pandemic. Liquidity creation measures the extent to which banks generate a money supply for the public, classified into liquidity created on the balance sheet and liquidity created both on and off the balance sheet categories. After controlling for macroeconomic and bank-specific variables, the results of a fixed-effects regression model reveal that next-period performance and stock returns deteriorate as liquidity creation levels increase. An inverted U-shaped relationship between liquidity creation (excluding off-balance sheet activities) and subsequent period performance is also observed, suggesting a trade-off between profitability and risk management. Furthermore, during a crisis, liquidity creation has a negative impact on bank performance and stock returns; however, this relationship is not significant when considering liquidity created on- and off-balance sheet activities and stock returns. This might be attributed to investors prioritizing on-balance sheet activities due to their immediate impact on a company's financial health, while off-balance sheet activities often involve non-cash credit and may have less short-term influence on stock returns. Additionally, a Mann-Whitney U test is employed to support the hypotheses; overall, it shows that increased liquidity creation is associated with lower performance. These findings provide valuable insights for policymakers, regulators, and investors regarding liquidity creation and its implications for bank performance and stock returns.