Effects of bank capital on liquidity creation and business diversification: Evidence from Malaysia

This paper examines the effects of bank capital ratios on liquidity creation and business diversification for Malaysia. Annual data are analyzed for 28 commercial banks for the period 2001⬜2017. We observe that the average equity capital and capital adequacy ratios trended upward over the period from 11 to 17% and from 19 to 27%, respectively. In connection with higher bank capital ratios, we find a general shift in bank focus away from traditional lending and deposit taking activity that creates liquidity for the economy toward fee-based services and other transactional business. More nuanced patterns emerge when banks are differentiated by size, stock market listing, and domestic versus foreign ownership. In particular, while traditional on-balance sheet liquidity creation is reduced across the board in connection with higher capital ratios, off-balance sheet liquidity creation (e.g., credit commitments) declines more selectively for larger, listed, and domestic banks. We infer that smaller, non-listed, and foreign owned banks have a competitive advantage in providing the more personalized services needed for off-balance sheet liquidity creation. Further, while an increase in business diversification in connection with higher capital ratios is broadly observed, the increase is not uniformly evident for larger and domestic banks.