Taxation and Bank Liquidity Creation

Abstract

We investigate the impact of taxes on bank liquidity creation using the Tokyo bank tax as a quasi-natural experiment. Drawing on data for Japanese banks, we find that the tax reduces retained earnings and capital, leading to a significant reduction in liquidity creation. The decline in liquidity creation is concentrated on the asset-side of bank balance sheets. Banks reduce the supply of long-term loans and shift toward short-term government securities. The results suggest that tax-induced erosion of capital constraints banks’ ability to provide liquidity through productive lending, and highlight the role of capital as a risk-absorbing buffer.