Regulatory enforcement actions and bank liquidity creation: Evidence from China

Abstract

We investigate how regulatory enforcement shapes bank liquidity creation, using a manually-collected dataset of administrative penalties combined with panel data for 368 Chinese commercial banks from 2010 to 2023. Employing a bank-level fixed-effects model, we find that enforcement causally enhances liquidity creation. This effect is not transitory, persisting for a 3-year period after sanctions. This positive effect operates through three channels: a strategic reallocation of bank portfolios, a strengthening of capital buffers, and an improvement in information disclosure. Furthermore, the effect is more pronounced for larger banks, for banks in regions with stronger supervisory capacity, and for sanctions targeting institutions rather than individual employees. Our study contributes to the literature by reframing the role of regulatory enforcement. We show that, rather than solely acting as a disciplinary constraint, well-designed sanctions can serve as a catalyst for beneficial adjustments in bank strategy and governance. This offers new insights into how supervisory design in emerging markets can bolster financial stability without compromising banks' financial intermediation capacity.