Bank capital and liquidity creation in Sub-Saharan Africa: the role of quality institutions

Abstract

PurposeThis study investigates the relationship between bank capital and liquidity creation and further examines the effect that institutional quality has on this relationship in Sub-Saharan Africa (SSA).Design/methodology/approachThe data comprise 41 universal banks in nine SSA countries from 2010 to 2022. The study employs the two-step system generalized methods of moments and further uses alternative estimators such as the fixed-effect and two-stage least squares methods.FindingsThe empirical results show that bank capital has a direct positive and significant effect on liquidity creation. In addition, the positive effect of bank capital on liquidity creation is enhanced, particularly in a strong institutional environment. The results imply that nonconstraining capital regulatory policies bolster bank solvency, improve risk-absorption capacity and increase liquidity creation.Practical implicationsThis study has several policy implications. First, it provides empirical evidence on the position of banks in SSA on the financial fragility and risk-absorption hypothesis of bank capital and liquidity creation debates. This study shows that the effect of bank capital on liquidity creation in SSA countries is positive and supports the risk-absorption hypothesis. Second, this study highlights that a country's quality institutions can complement bank capital to increase liquidity creation. In addition, this study highlights that nonconstraining capital regulatory policies will bolster bank solvency, improve risk-absorption capacity and increase liquidity creation.Originality/valueThe novelty of this study is that it introduces the country's quality institutional environment into bank capital and liquidity creation links for the first time in SSA.