Liquidity creation efficiency means the ability of transforming liquid liabilities to illiquid assets through on-balance sheet or off-balance-sheet activities like loan commitments and lines of credit. The research field belongs to the theory of financial intermediaries. Through the literature review, after the definition of liquidity creation was raised by Bryant （1980）, Diamond and Dybvig （1983） and Kashyap et al （2002）, this research field has been greatly developed. Berger and Bouman （2009） investigated the measurement based on categories of assets, liabilities, equity, and off-balance-sheet issues. This measurement describes the absolute level of bank liquidity creation, indicating the liquidity creation level for the economy provided by banks. Berger and Bouman （2009）’s contribution of quantifying the liquidity creation induces the research field from theory to empirical study. From the realistic view, although China’s direct funding market has made a great progress, it is still undeveloped as 80% of the liquidity is provided by bank system, owing to imperfect capital market construction. Therefore, the liquidity creation efficiency somehow directly determines the efficiency of the whole Chinese financial system. It seems that the governments intend to increase banking competition or reduce banking market power to enhance the liquidity creation efficiency by state-owned banks, joint-stock system reform, interest rate liberalization as well as the revision of Deposit Insurance Act and Law of Commercial Bank. However, the fact is that, although the market is expanding and the number of financial intermediaries is continuously increasing as well as the deposit and loan balance, the liquidity creation efficiency is not as good as expected. A large number of bank funds self-circulate within the financial system in the form of interbank deposits, loans and other financial innovations, and do not enter the real economy, making the development of the most innovative small-and-medium-sized enterprises in the economy greatly hampered. The problem of lacking innovation is the " Achilles heel” of China’s economy. How to innovate Chinese commercial banks’ ability of liquidity creation and expand the financial funding resources at institutional level has been one of the most important issues of Chinese financial system reform. Against this background, we use Panzar-Ross model, Lerner Index and Berge and Bouwman （2009）’s measurement to study Chinese commercial banks’ market competition, banking market power and liquidity creation efficiency. We improve these three types of measurement and study the relationship among these three indicators. It shows that, firstly, there exists a reverse U-shape relationship between market competition and liquidity creation efficiency, so there is a best market structure in the banking system. Secondly, the excess market power is an important factor that contributes to the low liquidity creation efficiency. The stronger the market power is, the lower the liquidity creation efficiency is. Thirdly, the market competition has no significant relationship with the market power, so the policy aiming to increase the competition to reduce the market power and solve the problem of the low liquidity creation efficiency will have limited effects. China should move forward along the direction of " improving the liquidity creation efficiency and enlarging the quantity of direct finance”. The study of liquidity creation is the advanced research field in the theory of modern financial intermediaries in the recent 30 years. Compared to former research, this paper has two major contributions to the field of efficiency study and Meso Economics study. This paper not only is a supplement to the research field, but also provides evidence and reference for the top-down design of bank reformation about the liquidity creation efficiency.
Market Competition, Banking Market Power and Liquidity Creation Efficiency: Evidence from Chinese Banking Industry
Journal of Finance and Economics Vol. 44, Issue 02, pp. 103 - 114 (2018) DOI:10.16538/j.cnki.jfe.2018.02.008
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Cite this article
Li Minghui, Huang Yeni, Liu Liya. Market Competition, Banking Market Power and Liquidity Creation Efficiency: Evidence from Chinese Banking Industry[J]. Journal of Finance and Economics, 2018, 44(2): 103–114.