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Liquidity Creation and Trust Environment

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Abstract

Trust towards banks plays a central role in theoretical literature. Diamond and Dybvig (J Polit Econ 91:401–419, 1983) argue that in a trustworthy environment banks can easily collect deposit foster banking activity and asset transformation. Diamond and Rajan (J Polit Econ 109:287–327, 2001) posit that a high trust environment discourages banks from creating liquidity. To address these conflicting views, the current study measures liquidity creation using Berger and Bouwman’s (Rev Financ Stud 22:3779–3837, 2009) methodology, then assesses the level of trust in the environment with four proxies and two additional instruments deployed in previous research. The results confirm a positive effect of trust in banks on liquidity creation, especially for small or state-chartered banks and during economic downturns. The results are robust to time effects and potential endogeneity concerns.

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Notes

  1. A deposit insurance scheme could have a similar effect, by reducing banks’ financial fragility and incentives to create liquidity. Fungáčová et al. (2017) explore this possibility but do not find a significant impact.

  2. http://web.mit.edu/cbouwman/www/data.html, last visited on 14/01/2019.

  3. In this calculation, we don’t take into account individuals answering “no opinion”.

  4. To test the sensitivity of our results, we use the sum of the “great deal” and “quite a lot” responses, and the average index of confidence. Results remain qualitatively similar and are available on request.

  5. Including the whole sample in the estimation yields a negative, significant coefficient for Bank Failure for both on- and off-balance sheet liquidity creation.

  6. Bernard Madoff’s fraud resulted in a momentous scandal in 2008. He ran a multi-billion-dollar Ponzi scheme for almost 20 years and defrauded more than 4,000 people, both individuals and institutions, for which he was sentenced to 150 years in prison. Hurt (2009) provides a detailed narrative of the scam.

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Acknowledgements

We thank Laura Spierdijk, Laurent Weill, and Ouarda Merrouche for their valuable comments. We also thank the participants of the Financial Engineering and Banking Society (FEBS) 2019 conference, the International Finance and Banking Society (IFABS) 2019 conference, and the 36th International Symposium on Money, Banking and Finance.

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Authors and Affiliations

  1. IESEG, School of Management, 3 Rue de la Digue, 59000, Lille, France

    Jérémie Bertrand

  2. Université Jean Moulin Lyon 3, Iaelyon School of Management, Magellan, 6 Cours Albert Thomas, 69008, Lyon, France

    Paul-Olivier Klein

  3. EM Strasbourg Business School, University of Strasbourg, 61 avenue de la Forêt Noire, 67085, Strasbourg Cedex, France

    Jean-Loup Soula

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  1. Jérémie Bertrand
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  2. Paul-Olivier Klein
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Correspondence to Paul-Olivier Klein.

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Table 10  Variables and Definitions
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Bertrand, J., Klein, PO. & Soula, JL. Liquidity Creation and Trust Environment. J Financ Serv Res 62, 201–232 (2022). https://doi.org/10.1007/s10693-021-00353-0

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