The effect of excess lending on bank liquidity : Evidence from China

This paper investigates the effect of excess lending on bank liquidity in China during the period 2006-2012. Previous studies have examined the determinants of bank liquidity. However, excess lending is neglected, especially the role of different lending channels. We consider a theoretical measure of liquidity, liquidity creation, and compare the results with an officially recommended measure suggested by the Basel III Committee. Excessive lending is captured in three dimensions, namely, relative lending, non-performing loan ratio, and diversification in lending channel. We find that the results of non-performing loan ratio support the trade-off hypothesis, whereas the results of lending channel diversification are consistent with our liquidity spiral hypothesis, especially for state-owned banks. Moreover, the interactions between capital and liquidity are negative for joint-stock commercial banks and state-owned banks rather than city commercial banks. Finally, the ownership structures significantly affect banks' liquidity preferences.