Bank Market Power and Liquidity: Evidence from 113 Developed and Developing Countries

Abstract

This paper investigates the association between market power and bank liquidity across 113 developed and developing countries. Using bank-level measures of market power (both a conventional and a funding-adjusted Lerner index) and Generalised Methods of Moments estimators, we find an inverse U-shaped relation between bank market power and liquidity. It shows that with initial increases in market power, banks hold more liquid assets, attract more non-transaction deposits and are net lenders in the interbank market. When market power exceeds a certain threshold, however, banks invest less in liquid assets, attract more transaction deposits and become net borrowers in the interbank market. We also find that for a given level of market power, ceteris paribus, banks in developed nations have lower investment in asset liquidity, attract more transaction deposits and obtain more funding through the interbank market than their developing country counterparts. These results are consistent across all models.

Keywords: Market power, bank liquidity, Lerner index

JEL Classification: C33, G21, G28, O23