First research to study effect of how bank regulators' interventions into troubled banks affect liquidity provision of t

January 20th, 2010

Despite a growth in bank regulation in the last few decades - and the likelihood that regulation will increase following the recent crisis, no evidence exists regarding how effective the measures are that financial regulators take when banks are in trouble and if this has wide ranging effects on banks' ability to supply liquidity to the economy.

A new piece of research to be conducted by Dr Klaus Schaeck of Bangor University Business School intends to address the gulf in the academic literature available. Schaeck intends to establish what effects different measures at the regulators' disposal have on the banks ability to supply liquidity to the economy - which is ultimately their core reason to exist.

Adopting newly devised measures of bank liquidity, Schaeck will apply these measures to a dataset for a group of banks to see how the liquidity generation of those banks was affected by the imposed regulatory interventions of various types.

The Research Project Grant, funded by The Leverhulme Trust is expected to be completed within 9 months and the results should influence public policy and policymaking in banking in any country where bank regulation is in place and intervenes to prevent a bank from collapsing.

Schaeck says, "The viability of a bank depends on its ability to produce liquidity- and governments have stepped in by creating regulating bodies as they do not want to see banks fail. The banking system's ability to take deposits and provide loans, is the oil that keeps our economy going. However, we don't fully understand the effects of regulatory actions on the banking system's ability to supply liquidity when they try to rescue failing banks."

"Any business that is limited in the scope of its activities is going to be affected in some way- it's the knock-on effect of these actions on a bank that is already in danger of collapse that we're particularly interested in. The intent is to better understand how to limit the scope of a bank's operations without unduly damaging its core function to supply liquidity to businesses and individual customers. This is done in the interest of preserving the institution, and also of preserving the supply of liquidity to the local economy" he explains.

The research will improve the financial regulator's understanding the effect of each of the different measures on the liquidity generation of the banks. This in turn will lead to improved policy responses to restore confidence in individual banks.

Dr Schaeck will collaborate with Thomas Kick from the German Central Bank and two U.S. academics who have recently developed the measure to assess liquidity creation in the banking system: Allen Berger who is affiliated with of the University of South Carolina, the Wharton Financial Institutions Center, and Tilburg University, and Christa Bouwman who is visiting MIT's Sloan School of Management. She is also affiliated with Case Western Reserve University and the Wharton Financial Institutions Center.

Provided by Bangor University