Canadian Bank Capital and Liquidity Creation*

Abstract

We find a significantly positive relationship between the Tier 1 capital ratio and on‐balance‐sheet liquidity creation for Canadian Big Six banks, implying that large banks in Canada can take risk due to risk absorption by using capital to fund illiquid assets. Our results are robust to the 2018 initiation of a domestic stability buffer (DSB) of total risk‐weighted assets for Pillar 2 risks, core deposits financing, non‐deposit funding restrictions, and bank mergers and acquisitions. The positive relation (regulatory capital ratio with liquidity creation) becomes significantly negative during the 2007–9 Global Financial Crisis and COVID‐19 pandemic.