Government Guarantees and Bank Liquidity Creation Around the World

Abstract

Governments provide guarantees to banks, such as deposit insurance, often increasing them during financial crises. While risk effects are well researched, impacts on bank output remain largely unexplored. We investigate bank output effects using data from 75 countries on bank liquidity creation, a comprehensive bank output measure. We address the reverse-causality identification challenge by examining effects of home country guarantees on liquidity creation by subsidiary banks in foreign host nations, and tackle omitted-variables concerns by specifying host country × year fixed effects. Our striking findings suggest that home-country guarantees increase decrease subsidiary bank liquidity creation by as much as 15%.