Capital buffer, credit risk and liquidity behaviour:

Evidence for GCC banks

Saibal Ghosh1

Abstract

We utilize data on GCC banks for 1996-2012 to test the interrelationships among credit risk, capital
and liquidity. Subsequently, we examine the liquidity behaviour of banks during the crisis. The
findings appear to suggest that risk, capital and liquidity are inter-related, with each tending to
substitute or complement the other. As well, banks that hoarded liquidity exhibited lower loan
growth, an effect that was multiplied during the crisis.
JEL classification: G21, G28

Key words: credit risk, liquidity hoarding, capital buffer, 3SLS, banking, GCC

1. Introduction
Traditionally, liquidity has not been a major concern for either banks or
regulators. The initial Basel Accord, which set capital standards for banks, provided
very little documentation about liquidity risk and the possible ways to address them.
Banks were not unduly concerned about the issue, regarding it more as the outcome of
the lack of trust (Diamond and Dybvig, 1983). Accordingly, empirical studies
traditionally employed liquidity ratios to measure bank liquidity, and regarded
liquidity risk as an exogenous variable (Demirguc Kunt and Huizinga, 1999; Barth et
al., 2004; Pasiouras and Kosmidou, 2007; Athanasoglou et al., 2008; Naceur and Kandil,
2013). Over time however, although the funding strategy of banks changed, the role of
liquidity and its management remained virtually unchanged.
This strategy of liquidity management was called into question in the wake
of the recent financial meltdown. The crisis revealed that liquidity risk at financial
institutions had significant consequences for financial stability, in part through
common asset exposures and their increased reliance on short-term wholesale funds.
Management of liquidity risk, in turn, spilled over to other markets and institutions,
contributing to each others' losses and exacerbating overall liquidity stress.

1 Centre for Advanced Financial Research & Learning, Reserve Bank of India, Main Building, Fort, Mumbai
400001. A significant portion of the work was done when the author was working with the Qatar Central Bank
in Doha, Qatar. The views expressed and the approach pursued in the paper reflects the personal opinion of
the author.

1
 The available literature provides two contrasting views regarding the
relationship between capital and liquidity for banks. On the one hand, borrower-
specific information might impel banks to extract monopoly rents, in turn dissuading
depositors from keeping money in banks. The alternate view proposes that higher
capital enhances bank's ability to create liquidity, since it increases banks' exposure to
risk and as a result, necessitates higher liquidity to meet customer demands.
Another strand of the literature focuses on the interaction between liquidity
and credit risk. Several papers have examined this issue in detail (Cai and Thakor,
2009; Acharya et al., 2009; Acharya and Vishwanathan, 2011). According to the basic
tenets of this theory, assets are illiquid and the lending and collection of loans is skill-
based. Therefore, if projects funded with loans yield insufficient funds and the bank is
not able to meet depositors' demands, they will pay more for deposits and/or fire-sale
loans, thereby lowering the net present value of projects (and the associated loans). As
the quality of loans deteriorates and more and more depositors claim back their
money, the bank calls back all loans, thereby reducing aggregate liquidity. In other
words, higher credit risk is accompanied with higher liquidity risk.
A final line of thinking is the interaction between credit risk and capital.
Both theoretical as well as empirical (Shrieves and Dahl, 1992; Aggarwal and Jacques,
2001; Jacques and Nigro, 1997; Rime, 2001; Ghosh, 2003; Stolz, 2007; Van Roy, 2008)
literature documents a relationship between risk and capital, which can either be
positive (since risk averse banks prefer low levels of capital) or negative (since banks
that are compelled to lower leverage in response to regulatory standards might end up
raising risk).
Against this background, we explore the interrelationhip among bank
capital, liquidity and credit risk for GCC banks by employing an extended sample
period that encompasses the recent global financial crisis.
These countries exhibit significantly financial asymmetries, which has been
accentuated by the spate of recent developments. Being predominantly bank-based in
nature, a manifestation of this process has been the large and growing differentials in
the levels of bank capital and levels of delinquent loans. By way of example, banks in
countries that have been severely impacted by the crisis have witnessed a sharp
decline in their capital position. The capital adequacy ratios of banks in Bahrain, for

2
example, which were 22% in 2006 have declined significantly post crisis, whereas
banks in Qatar have witnessed a perceptible improvement in their capital position.
Likewise, in several countries, banks’ NPLs have witnessed a sharp rise. UAE banks for
example, exhibited a sharp increase in their NPLs, partly reflecting the fallout of the
Dubai World episode in 2009. All this has occurred amidst significant changes in bank
penetration across countries (Table 1). Second, while the presence of Islamic banks
have imparted stability to these economies, especially during the crisis (Akthar Aziz,
2009; Yilmaz, 2009), the dual nature of the banking system – wherein conventional
banks co-exist with Islamic ones - has also engendered significant differences in
liquidity positions across banks. As Ali (2011) remark, limited access to market
liquidity coupled with the absence of a LoLR facility had made the Islamic banks
particularly vulnerable to liquidity shocks. Third, the uneven impact of the Arab Spring
across countries has led to a gradual increase in the break-even oil price (that allows
the country to achieve fiscal balance), mainly owing to the various stimulus measures
undertaken by the government in response to the political and social uprisings. For
example, the total costs on social measures, defined as amount spent on wages,
subsidies, transfers, infrastructure and job creation ranged from around 0.5% of GDP
in the UAE to over 10% in Saudi Arabia (IMF, 2011; World Bank, 2011). [Table 1]

Besides the interest in the research question, the paper also adds to the extant
literature in two distinct ways. First, we investigate the liquidity hoarding behaviour of
banks and analyse its proximate determinants, an aspect that has attracted limited
attention in the literature, and specifically in the context of GCC banking systems.
Studies for developed banking markets, such as the UK (Acharya and Merrouche,
2011) and US (Wolman and Ennis, 2011) provide evidence in support of liquidity
hoarding by commercial banks. In case of GCC banks, since liquidity management
decisions are likely to be asymmetric across banks characteristics and ownership, it
remains a moot question as to how the liquidity response of these banks evolved
around the crisis. Second, we explore, in addition to the above, the role of liquidity
hoarding in affecting banks' lending behaviour. In the case of US banks, Berrospide
(2013) has documented that, in response to heightened concerns of uncertainty
surrounding the economic risks, banks reallocated their assets from riskier loans to

3
safe and liquid securities. A natural corollary of this fact seems to be that such banks
would cut back on their lending. Whether such liquidity hoarding led to a contraction
in loan supply is an issue that we empirically explore. To the best of our knowledge,
this is one of the earliest studies for GCC countries to examine this issue in a systematic
manner.
The GCC banking system provides a compelling case to examine this issue in
detail. Firstly, these countries share similar economic and social characteristics and
are essentially dependent on hydrocarbon and its derivative products for export
revenues. On average, hydrocarbon accounts for half of the region's GDP, contributes
over 70% of merchandise exports and over three-fifths of government revenues (IMF,
2010a). Following the oil boom, real GDP growth in these countries averaged over
6.5% during 2003-08 as compared to less than 4% during the preceding five-year
period. Non-oil GDP growth improved markedly, averaging nearly 7.5% during this
period (IMF 2010 a,b; 2011). The economic crisis and its after-effects, including the
headwinds of the Arab Spring slowed down these economies considerably, with real
GDP growth dwindling to 0.3% in 2009, although growth has since turned a corner,
averaging close to 6% during 2010-12 (IMF, 2013; Ghosh, 2015)2. The fiscal and
external positions also turned the corner, providing headroom to the authorities for
greater economic diversification, while allowing the surpluses to be invested for
productive purposes.
We contribute to the literature in a few important ways. First, we exploit the
asymmetries in capital, liquidity and credit risk position of GCC banks and examine their
interlinkage. This assumes all the more relevance since the importance of liquidity as a
determinant of capital buffer has not been adequately addressed in the literature. The
funding liquidity argument suggests that bank hold capital buffer in order to withstand
the losses from selling illiquid assets in order to meet unforeseen liquidity withdrawals.
In such a situation, higher capital buffers acts as a signalling mechanism indicating their
solvency.
Second, following recent advances (BIS, 2012; IMF, 2011a; Federico and
Vazquez, 2012), we compute a sophisticated measure of liquidity - the net stable

2Much of the high growth during 2010-12 in the GCC countries can be traced to the high GDP growth of Qatar,
which grew at 16.6 and 13% during 2010 and 2011, respectively. Excluding Qatar, the average growth rate of
GCC during this period is around 4.7%.

4
funding ratio or NSFR - to examine its relationship with bank capital and risk. This
enables us to examine the relevance of an important variable that has been advocated
in recent policy discussions.
Finally, the paper also adds to the literature that analyses the impact of the
recent financial crisis. Several studies have examined the behavior of U.S. banks during
the crisis (Ivashina and Scharfstein, 2010; Cornett et al., 2011; Huang, 2010; Santos,
2011). However, the interplay between bank capital and its interplay with liquidity
during the crisis and across ownership for GCC banks that has not been empirically
addressed in prior research.
To anticipate the results, the findings indicate that risk, capital and liquidity
are inter-related. Additionally, the evidence supports the fact that banks that hoarded
liquidity exhibited lower loan growth, an effect that was multiplied by the crisis.
The rest of the analysis continues as follows. Section 2 provides an overview
of the relevant literature. This is followed by the database and variables employed in
the study, followed by the empirical strategy (Section 4), results (Section 5) and
concluding remarks (Section 6).

II. Model, Theory and Hypotheses

In order to have a sufficiently broad perspective on capital buffer, we model
liquidity, credit risk and capital in a simultaneous equation setup. Accordingly, we first
specify an empirical framework and thereafter, propose several hypotheses.
Theoretical models suggest several determinants of capital buffers (BUF),
liquidity (LQDTY) and credit risk (CRISK). Moreover, theory also suggests that the
three choices might be determined jointly. Taking these observations on board, we
propose the following three-equation model for bank b at time t:
CRISK bt   1 NSFRbt   2 BUFbt   1' [Controls]bt   1' [OWN ]bt  1,bt
(1)

NSFRbt   1 CRISK bt   2 BUFbt   2' [Controls]bt   2' [OWN ]bt  2,bt

(2)
BUFbt  1 NSFRbt   2 CRISK bt   3' [Controls]bt   3' [OWN ]bt  3,bt
(3)
The model contains a set of explanatory variables (Controls) and includes
dummies for bank ownership (OWN). In order to ensure identification of these three
equations, we need to ensure that the set of control variables included in each

5
equation are sufficiently different; the ν's are the error terms. Therefore, in the
remainder of this section we review extant models concerning bank capital buffer,
liquidity and credit risk.

II.1 Liquidity and Capital

The theoretical literature provides two views on the relationship between
bank capital and liquidity. Under the first view, bank capital tends to impede liquidity
creation through two effects: the financial fragility/crowding out structure and the risk
absorption hypotheses. Under the financial fragility hypothesis, the process of
intermediation between depositors and borrowers provides banks with private
information about the borrowers that provides them with an advantage in assessing
their repayment capacity. On the flip side, this informational advantage engenders an
agency problem, so much so that the bank may impel depositors to pay a higher cost
and thereby, extract a greater share of appropriable rents. Recognizing this possibility,
depositors become reluctant to put their money in the bank, leading to a ‘fragile’
financial structure, characterized by lower capital (Diamond and Rajan, 2000, 2001),
while higher capital ratios may crowd out deposits and thereby reduce liquidity
creation (Gorton and Winton, 2000).
Under the second hypothesis, higher capital enhances the ability of banks to
create liquidity. Here, liquidity creation increases the bank’s exposure to risk, as its
losses increase with the level of illiquid assets to satisfy the liquidity demands of
customers (Allen and Gale, 2004). Bank capital allows the bank to absorb greater risk
(Bhattacharya and Thakor, 1993; Repullo, 2004). Capital absorbs risk and expands
banks’ risk-bearing capacity (Von Thadden 2004, Coval and Thakor 2005). Therefore,
the higher is the bank's capital ratio, the higher is its liquidity creation.
The empirical literature has focused on the relationship between bank
capital buffer and liquidity, after controlling for other proximate determinants. In an
early study, Lindquist (2004) utilized data on Norwegian banks to study the behavior
of bank capital buffer and show that these fluctuate counter-cyclically over the
business cycle. Subsequent studies on the association between risk and capital buffers
report mixed findings (Lindquist, 2004; Jokipii and Milne, 2011).

6
II.2 Liquidity and Credit Risk
A significant body of literature has focused on liquidity and credit risks in
banks. Two broad strands have emerged. The first is the financial intermediation view.
This model view banks as pools of liquidity that provides both savers and investors
with ready cash, in turn, internalizing liquidity risk and promoting economic welfare
(Diamond and Dybvig, 1983). The other - the industrial organization approach a la
Monti-Klein - models banks as entities that maximize the spread between deposit and
loan rates in their quest for profit maximization. In this set-up, a loan default increases
illiquidity risk because of the lowered cash inflows, indicating that illiquidity risk and
credit risk should be positively related.
The idea of a positive relationship between liquidity and credit risk is
supported by recent advances in the literature (Diamond and Rajan, 2003; Acharya
and Viswanathan. 2011). It is assumed that assets are illiquid and the bank obtains
money from deposit that it invests in projects, whose evaluation is skill-based. When
too many projects funded with loans yield insufficient funds (or even default) and the
bank is unable to meet depositor withdrawals, it pays higher cost to attract the
withdrawn (old) deposits. In the process, banks resort to fire sales existing assets
(projects), thereby not allowing these projects to reach fructification. As the quality of
banks asset deteriorate and more and more depositors claim their money back, the
bank is compelled to call in all loans, thereby reducing aggregate liquidity in the
market. In essence, higher credit risk is accompanied by higher liquidity risk through
depositor demand.
In a similar vein, Acharya and Viswanathan (2011) also propose a
framework that explains the interrelationship between liquidity and credit risk. In
their model, the severity of a crisis is higher, the larger the build-up of leverage in good
economic times. Financial firms raise debt with which to finance assets. At maturity,
the weaker the quality of these assets, higher is the incentive to roll these over with
riskier assets. The higher the leverage, the worse the problem becomes, because the
more difficult it is for banks to get rid of these assets. The net outcome is that higher
leverage results in higher liquidity risk. Therefore, in times of distress when asset
prices deteriorate, banks also find it more difficult to roll over debt, i.e. they have a
liquidity problem.

7
 An evolving literature postulates that the link between liquidity and credit
risk in banks might, in fact be negative. Higher asset liquidity facilitates the sale of
bank assets in crises and thereby reduces the banks' incentives to avoid them. As a
result, banks might be tempted to assume greater risks and thereby raise the
probability of default (Wagner, 2007; Tabak et al., 2012). Acharya et al. (2009) build
on the empirical evidence that the cash holdings of banks increased steeply during the
recent financial crisis. The authors develop an analytical framework in which liquidity
holdings are an ex-ante strategic choice of bank management in order to purchase
assets of other banks at fire sale prices in times of economic distress. As a result,
increased bank asset liquidity can engender heightened bank instability. The
postulated relationship between liquidity and credit risk is therefore negative. Acharya
and Naqvi (2012) show that during times of macroeconomic stress, households and
corporate depositors place their assets with banks. This, in effect, provides banks with
adequate liquidity and in turn lowers their “quality” of monitoring of new and existing
borrowers. The implication is that banks with higher liquidity holdings can load their
loan portfolio with “bad” loans.

II.3 Capital and Credit Risk

The literature on the relationship between bank capital and risk can be
classified into theoretical and empirical components. In an early study, Kim and
Santomero (1988) had observed that risk-averse banks would prefer higher levels of
capital. Such a negative relationship has been advocated by other researchers as well
(Diamond and Dybvig, 1986). A negative relationship between risk and capital can also
occur when all deposits have flat rate insurance, since in that case, the marginal cost of
increasing risk or lowering capital is insignificant.
The other line of thinking contends a positive association between bank
capital and risk (Koehn and Santomero, 1980; Kim and Santomero, 1988). The
application of minimum regulatory standards may cause banks to view leverage and
risk to become substitutes. As a result, in response to regulatory requirements, a bank
that is forced to lower its leverage might end up raising its risk.

8
 Another line of argument derives from the fact that higher capital
requirements lower the charter value of banks, in turn, compelling them to assume
higher risks (Besanko and Kantas, 1996; Hellmann et al., 2000).
Starting with the work by Shrieves and Dahl (1992), several empirical
studies have employed credit risk as the measure of risk (Berger and De Young, 1997;
Salas and Saurina, 2003; Williams, 2004; Fiordelesi et al., 2010). Following from this
research, several studies have investigated the capital-credit risk relationship, with
mixed results. In case of US, studies found that banks responded to the new capital
standards by increasing risk (Jacques and Nigro, 1997; Aggarwal and Jacques, 2001),
whereas cross-country studies report a negative association between capital and risk
(Van Roy, 2008).

III. Database and Variables

III.1 Database
The analysis employs a detailed bank-level dataset. The core of the data is
the information on bank’s balance sheet and income statement details as published by
Bankscope, a comprehensive, global database containing information on nearly 30,000
public and private banks globally, maintained by International Credit Analysis Limited
(IBCA).
We use a sample comprising of an unbalanced panel of annual report data
from 1996-2012 for the GCC banking system, comprising conventional and Islamic
banks. The sample initially contained 112 banks, but subsequently we deleted the
finance and investment companies, leaving us with 105 banks. Several banks also do
not report data on the dependent variables, which we exclude from the sample. After
this filtering, we have observations on 103 banks at an average of 10.3 years of
observations, yielding a maximum of 1065 bank-years. To moderate the influence of
outliers, we winsorized the top and bottom 1% of observations for the variables. In
2012, the final year of the sample, these banks accounted, on average, for nearly 80%
of total banking assets in their respective countries.
The sample composition in Table 2 indicates that nearly 45% of the banks are
Islamic; the remaining are conventional (which can also include Islamic windows).
Close to 70% of the banks are publicly listed. Islamic banks dominate in Bahrain,

9
whereas it is non-existent in Oman, where the permission for such banks is of fairly
recent origin.
Table 3 provides a description of the relevant variables. Overall NPLs in the GCC
countries averaged 3.6% during the period. Banks appear to be maintaining adequate
capital buffers with comfortable liquidity levels. As regards the control variables, the
average total assets of the bank translates into a book value of roughly USD 3000 million.
Loan book comprises roughly 50% of bank assets, on average. On the funding side,
reliance on short-term funding appears to be limited, comprising 14% of total assets; the
value at the 75th percentile being 20%. This can be one of the reasons as to why GCC banks
were not unduly impacted by the US sub-prime crisis. Banks appear to be well-diversified.
The Stiroh (2004) diversification index, which ranges between zero (no diversification)
and 0.5 (maximum diversification) suggests that the average diversification index for GCC
banks equal 0.36.
[Table 2]
[Table 3]

III.2 Measurement of Credit Risk

Following from our previous discussion, we employ non-performing loan
ratio as the preferred risk measure. This is a widely employed measure, having been
utilized in several studies (Shrieves and Dahl, 1992; Kwan and Eisenbis, 1997; Salas
and Saurina, 2002; Karim et al., 2010).

III.3 Measurement of Capital

Capital buffer is measured in two ways. The first is the absolute capital
buffer, defined as the actual capital to risk-weighted asset ratio (CRAR) less stipulated
minimum CRAR divided by the stipulated minimum CRAR. However, for two banks
with the same BUF, the variability could be higher for one vis-a-vis the other. Taking
this consideration on board, we employ the standardized capital buffer (SBUF), which
equals BUF scaled by the standard deviation of the actual capital adequacy ratio over
the observation period.

III.4 Measurement of Liquidity

10
 Following the subprime episode and in recognition of the need for banks to
improve their liquidity management, the Basel Committee on Banking Supervision has
proposed a net stable funding ratio (NSFR), which is intended to incentivize banks to
fund their activities with stable sources of funding on an ongoing basis. The measure is
computed as the available amount of stable funds to the required amount of stable
funds: larger weights on available funds (liabilities) indicates more stable funding
sources, whereas larger weights on required funds (assets) denotes less liquid
positions. We follow Vazquez and Federico (2012) and calculate NSFR for each bank-
year pair: a higher value of the ratio indicating greater liquidity. The average NSFR
value equals 1.61, suggesting that GCC banks have high levels of stable funding.

III.5 Control Variables

In the capital equation, the control variables include size and profitability.
Size is measured as the logarithm of total assets. Bigger banks are likely to be able to
access equity markets more easily and therefore, expected to have lower capital ratios.
Alternately, given the concentrated banking systems that typify these economies,
larger banks might be tempted to expand faster to fund asset growth and therefore,
need higher capital levels. In the presence of asymmetric information, profitable banks
might prefer to increase capital through retained earnings, suggesting an expected
positive sign on this variable.
The main control variables in the risk equation include size, funding profile,
index of income diversification and inefficiency. Larger banks carry out a wider set of
activities, which should increase their ability to diversify portfolios and lower credit
risk. Second, banks with greater dependence on wholesale funds are likely to be
perceived as more risky, as recent evidence would testify (Raddatz, 2010). On the
other hand, it is not evident whether banks with diversified income stream are more
or less risky, since the empirical evidence, both for the U.S. and around the world is
mixed (Stiroh, 2010). Authors like Hughes et al (1994) and Kwan and Eisenbis (1997)
emphasize the importance of analysing the impact of efficiency on bank risk taking.

11
Using data on US banks, they uncover a negative relationship between inefficiency and
bank risk.
Finally, in the liquidity equation, following recent research (Cornett et al.,
2012; Berropside, 2013), the control variables are size, illiquid assets, core deposits
and security gains (losses).
Besides, we include dummy to distinguish between Islamic and
conventional banks, in addition to a dummy for listed banks. All equations control for
country and year shocks by including an interaction term between country and year
fixed effects.
Given the simultaneous equation setup of (1), (2) and (3), the empirical
strategy has to account for the endogeneity of the regressors. In contrast to the
ordinary least squares, 2SLS and 3SLS estimators take the endogeneity into account,
thereby producing consistent estimates. As Zellner and Theil (1962) have observed,
3SLS exploits the information that the disturbance terms in the two structural terms
are contemporaneously correlated and thereby ensures consistent estimates3 Since
the estimates under the two models are similar, we present the results using the 3SLS
technique.
Before discussing the results, Table 4 sets out the descriptive statistics of
the dependent and independent variables, both for the overall sample as well as for
sub-samples, classified according to ownership and listing. The results indicate that,
on average, Islamic banks have much lower NPLs as compared to conventional banks.
On the other hand, conventional banks appear to have much higher levels of liquidity
and their capital buffers are much higher as well. All these differences are statistically
significant at the 0.01 level. Similar differences are also evidenced for listed and
unlisted banks.
[Table 4]
NPLs of Islamic banks appear to be higher during periods of crisis, although
these numbers were significantly lower during non-crisis times. On the other hand,
liquidity of Islamic banks are much lower, both during periods of crisis and otherwise.

3 The3SLS methodology is sensitive to misspecification or measurement errors. As a result, a comparison with

2SLS estimates as a specification check becomes relevant. In the present case, estimation of equations (5) and
(6) with 2SLS produce results similar to those obtained under 3SLS.

12
The evidence runs contrary to the argument by Ali (2011) which contends that Islamic
banks typically have higher liquidity levels.

IV. Discussion of the Results

IV.1 Baseline Results
Two sets of results are set out in Table 5. Specification 1 estimates the
model where capital is estimated by BUF. In the other model, capital is estimated by
SBUF.
[Table 5]
We first examine the response of endogenous variables. First, parameter
estimate of BUF in the risk equation and the coefficient on NPL in the capital equation
are both negative and highly significant. In other words, increase in capital is
associated with lowering of risk, and likewise, increase in risk is associated with a
decline in bank capital. This negative relationship between capital and risk has been
widely documented in the empirical literature, both for the US banking industry
(Aggarwal and Jacques, 2001) and elsewhere (Heid et al., 2004; Das and Ghosh, 2007)
and could be explained by the fact that higher capital in excess of capital requirement
is linked to a lower risk appetite. The estimates are significant in economic terms, as
well. Thus, a bank with BUF equal to 1.33 - equal to the 75th percentile of the
distribution – would experience a decline in NPLs by 89% more as compared to a bank
with BUF equal to 0.44, which belongs to the 25th percentile of the distribution.
Liquidity and credit risk are positively related, consistent with recent
research which postulates that banks with higher liquidity tend to compromise the
quality of their loan portfolio, resulting in higher credit risk (Diamond and Rajan,
2003; Acharya and Vishwanathan, 2011). Likewise, the positive impact of liquidity in
the capital equation would suggest that banks tend to increase buffer when their
liquidity levels are higher: a 10% rise in liquidity improves capital buffers by roughly
8% points. The results indicate that an increase in capital buffer by banks could be a
response to secure their access to external financing or alternately, reinforce the
ability to repay their liabilities.
In the NSFR equation, the coefficients on both NPL and BUF are positive and
statistically significant. In essence, higher NPL impels banks to improve liquidity in

13
order to meet depositor claims, whereas banks with capital levels prefer to maintain
higher liquidity, consistent with the crowding out hypothesis. The results are
directionally similar when SBUF is employed as the capital measure.
Among the control variables, the coefficient on Size is negative in the NPL
and BUF equations, but positive in the NSFR equation. In other words, since bigger
banks are better able to diversify risk (and thereby control NPLs), they operate with
lower levels of capital. On the other hand, bigger banks have higher liquidity levels,
which could be evidence in support of liquidity hoarding, an aspect we examine later
in the analysis. As hypothesised by Flannery and Ragan (2008), profitable banks tend
to hold higher levels of capital buffer, since they benefit from their ability to
accumulate capital from internally generated funds. Contrary to Ayuso et al. (2004)
however, banks involved in credit activities (proxied by loan-to-asset ratio) do not
appear to hold any significant level of capital buffer.
Coming to market discipline, listed banks are observed to have higher NPLs
and capital buffers as compared to unlisted banks, although they have lower levels of
liquidity. This might indicate the tendency for listed banks to assume higher risks,
given their high buffers.
Looking at ownership, when significant, the coefficient on Islamic is
negative, indicating that, after controlling for bank specific and country-year
characteristics, Islamic banks have lower NPLs and capital buffers as well as lower
liquidity as compared to conventional banks. The effect is quantitatively important,
indicating that for the average Islamic bank, NPLs are roughly 0.03 percentage points
higher as compared to an average conventional bank. Considering the average capital
change in the sample equal to 0.036, this is however, not a sizeable difference.

IV.2 Liquidity Hoarding and Bank Lending

A key issue of relevance in this context is the behaviour of bank liquidity
during the crisis. Our previous analysis appears to provide some inkling that banks
could have resorted to liquidity hoarding during the crisis. To investigate this further,
we examine the determinants of bank liquidity hoarding and subsequently, explore
whether liquidity hoarding impacted their lending behavior.

14
 We perform this analysis in two steps. First, we examine the determinants of
bank liquidity hoarding. Using bank-level data, Berrospide (2013) documented the
determinants of liquidity hoarding for US banks. Likewise, de Haan and van den End
(2013) examined the issue for Dutch banks, Acharya and Merrousche (2010) for UK
banks and Mutu and Corovei (2013) for European banks. Subsequently, we examine
the impact of liquidity hoarding on bank lending.
In Table 6, we report the results of a probit regression wherein the bank's
decision to hoard liquidity is assumed to be a function of its size, capital buffer and
deposits. Akin to Berrospide (2013), we define liquidity hoarders as banks with NSFR
increase between two consecutive periods of 2% or more. This contrasts with Mutu
and Coravei (2013) who define liquidity hoarders as banks with their liquidity to
deposits and short-term funding in excess of 75th percentile.4 In addition, we also
include risk measures such as NPLs, and exposure to losses on securities portfolio. We
control for country-year effects to capture time-varying and country-specific
characteristics impacting banks in each country.
[Table 6]
The results suggest that bank size is negatively correlated with the decision to
hoard liquidity, which suggests that smaller banks are more likely to become liquidity
hoarders, consistent with previous evidence for the US (Berrospide, 2013) and
European (Mutu and Corovei, 2013). The share of NPLs is also strongly and positively
associated with the decision to hoard liquidity. Employing these estimates, we
compute the predicted value of liquidity hoarding that we utilize in our subsequent
analysis.
The previous analysis appears to suggest that smaller banks are more likely
to hoard liquidity and more so, as a response to higher asset portfolio risk. Advancing
the argument further, we explore whether liquidity hoarding matters for bank loan
growth. Towards this end, we run the following regression specification for bank b at
time t given by specification (4):
Loanbt   o  1 LH bt   2 ( LH ) bt *Crisis t 
 3 [Controls]bt  Country * Year   bt (4)

4 We also experimented with this methodology. The results (not reported) are observed to be not statistically
significant.

15
 In Eq. (4), ∆Loan is the change in log loans between two consecutive periods, LH is
a dummy that equals one if a bank is a liquidity hoarder in a particular year, else zero,
LH*Crisis examines the response of liquidity hoarders during the crisis. The model
includes a set of controls including bank size, capital buffers and non-performing
loans. Higher liquidity hoarding during the crisis would mean that banks would lower
lending, so that µ2<0.
However, the decision to hoard liquidity is likely to be endogenous. For
example, a bank might decide to hoard liquidity in response to lack of lending
opportunities. As a result, low lending might lead to higher holding of liquid assets. To
address these concerns, in addition to employing liquidity hoarding variable, we also
employ the predicted liquidity values.
The results are set out in Table 7. We first briefly discuss the control
variables. Size is negative and significantly related to the dependent variable,
suggesting that credit growth is slower in bigger banks. In general, large banks are
generally perceived to be less risky, due primarily to greater possibilities for
diversification and better access to financial markets. It is also possible to envisage
that large banks have more risky loan portfolios and lower capital ratios, thereby
offsetting their potential diversification benefits (Demsetz and Strahan, 1997). The
evidence suggests that the latter evidence outweighs the former. Economically, a 10%
increase in size lowers loan expansion by roughly 0.05% points. As well, the results
appear to indicate that banks with higher capital buffers increase loan supply. This is
consistent with the literature that suggests that bank soundness is an important factor
influencing bank credit decisions (Nier and Zicchino, 2005). High NPLs act as a
dampening effect on credit growth, as expected.
Our major variable of interest is the coefficient on liquidity hoarding and its
interaction terms. Models (1)-(3) identify liquidity hoarders based on their dummy
for liquidity hoarding, whereas the remaining three models employ its predicted
value. All these variables enter the regression specification with the expected sign and
are statistically significant.
In Model (1), the coefficient on LH is negative with a point estimate equal to
-0.07. In other words, higher liquidity tends to lower bank lending, as expected. Col.(2)
includes, in addition to LH, its interaction with a crisis dummy. The coefficient on both

16
LH and LH*Crisis are negative, suggesting that the magnitude of liquidity hoarding
tends to increase during the crisis, in turn, dampening lending (the coefficient on
LH*Crisis in Col.2 is roughly one-and-a-half times that on LH). Liquidity hoarding
however, does not appear to be significantly different for Islamic banks. The latter
could be explained by the fact that Islamic banks require a collateral backing for their
lending; hence, irrespective of their liquidity position, they did not display any
perceptible difference in their lending behaviour.
The results are manifest more starkly in Cols.(4)-(6) where we control for
the endogeneity of liquidity. In Col(4), for example, the coefficient on Predicted LH
equals -0.57, suggesting that liquidity hoarders lower their annual loan growth by
nearly 0.6% more as compared to liquidity non-hoarders. When we include its
interaction with crisis, the coefficient is three times as large as the coefficient on
Predicted LH, implying that the negative propensity to be a liquidity hoarder on loan
growth becomes more strongly manifest during the crisis. As earlier, there is no
discernible impact of bank ownership on loan growth for liquidity hoarders.
The magnitudes are not only statistically significant, but also economically
significant, as well. To see this, note that the banks that hoard liquidity had loan
growth that is nearly 0.6% points lower as compared liquidity non-hoarders. Taking
into account that banks that hoard liquidity reduced their annualized loan growth by -
2.5% during the crisis, this suggests an important economic effect: one-sixth of the
reduction in bank lending during the crisis is explained by precautionary liquidity
hoarding.
[Table 7]

V. Concluding remarks
The relationship between capital and risk and between risk and liquidity
has been widely discussed in the literature. None of the studies however undertakes a
holistic assessment of the relationship between risk, capital and liquidity within a
cogent framework.
In this context, the present paper employs data on an extended sample of
GCC banks for the period 1996-2011 to examine this issue in detail. Three major
findings emerge. First, risk, capital and liquidity are inter-related, with each tending to
substitute or complement the other. Second, Islamic banks have lower NPLs and

17
capital buffers as well as lower liquidity as compared to conventional banks. Third,
banks that hoarded liquidity exhibited lower loan growth, an effect that was multiplied
during the crisis.
These findings have important implications for policy. First, increased
uncertainty might increase the appetite of banks to hoard liquidity, not only to meet
the demand for funds from illiquid banks, but perhaps also in order to meet the
response of depositors' demands. Second, the paper highlights the importance of
liquidity in impacting the relation between risk and capital. Therefore, a more pro-
active focus on liquidity is important in the context of proposed regulatory reforms for
banking institutions as part of the Basel III framework. Finally, the evidence indicates
the need for measures to improve the liquidity levels for Islamic banks, which appear
to be significantly lower as compared to conventional banks.

References
Acharya V. and O.Merrouche (2010). Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence
from the Sub- prime Crisis, NBER Working Paper 16395, Cambridge: MA.
Acharya, V. and S.Vishwanathan (2011). Leverage, moral hazard and liquidity. Journal of Finance 66, 99-138.
Acharya, V., D. Gromb, and T. Yorulmazer (2009). Imperfect Competition in the Interbank Market for Liquidity
as a Rationale for Central Banking. Working Paper, New York University Stern School of Business.
Aggarwal, R. and K. Jacques (1997). A simultaneous equations estimation of the impact of prompt corrective
action on bank capital and risk. In Financial Services at the Crossroads: Capital Regulation in the 21st
Century, Federal Reserve Bank of New York.
Akthar Aziz, Z. (2009). Islamic finance and financial stability. Address delivered at the High Level Conference
on Financial Stability, Bank Negara Malaysia, Kuala Lampur. Available at <www.bis.
org/review/r091130d.pdf>
Alfon I., I Argimon and P. Bascunana-Ambros (2004). What Determines how Much Capital is Held by UK Banks
and Building Societies, Occasional Paper Series 22, FSA, London.
Ali S S (2011). Islamic banking in the MENA region. Financial Flagship Report. The World Bank: Washington
DC.
Allen, F. and D.Gale (2004). Financial intermediaries and markets. Econometrica 72, 1023- 1061.
Athanasoglu, P.P., S.Brissimis and M.D.Delis (2008). Bank-specific, industry specific and macroeconomic
determinants of bank profitability. Journal of International Financial Markets, Institutions and Money
2, 121-36.
Ayuso, J., D.Pérez, and J. Saurina (2004). Are capital buffers pro-cyclical? Evidence from Spanish panel data.
Journal of Financial Intermediation, 13, 249-264.
Barth, J., G. Caprio and R. Levine (2004). Bank Supervision and Regulation. What Works Best? Journal of
Financial Intermediation 13, 205-48.
Basel Committee for Banking Supervision (2012). International regulatory framework for banks. BIS: Basel.
Berger, A. N., R.Herring and G. Szegö (1995). The role of capital in financial institutions. Journal of Banking and
Finance 19, 393-430.
Berrospide J. (2013). Liquidity Hoarding and the Financial Crisis: An Empirical Evaluation, FEDS Working
Paper No. 03, Federal Reserve Board: Washington DC.
Besanko, D.,and G.Kantas (1996). The regulation of bank capital: Do capital standards promote bank safety?
Journal of Financial Intermediation 5, 160-83.
Cai, J. and A.V.Thakor (2009). Liquidity risk, credit risk and interbank competition. DOI 10.2139.
Cornett, Marcia, Jamie J. McNutt, Philip Strahan, and Hassan Tehranian (2010). Liquidity Risk Management and
Credit Supply in the Financial Crisis. Journal of Financial Economics 101, 297-312.

18
Das, A. and S.Ghosh (2004). The relation between risk and capital: Evidence from Indian public sector banks.
RBI Occasional Papers (Summer), 1-21.
Das, A., and S.Ghosh (2007). Determinants of credit risk in state-owned banks: An empirical investigation.
Economic Issues 12, 48-66.
De Haan L., and E Van den (2013). Banks' responses to funding liquidity shocks: Lending adjustment, liquidity
hoarding and firesales, International Financial Markets, Institutions and Money 26, 152– 174.
Demirgic-Kunt, A. and H.Huizinga (1999). Determinants of Commercial Bank Interest Margins and
Profitability: Some International Evidence. World Bank Economic Review, 13, 379-408.
Demirgüc-Kunt, A. and H.Huizinga (2010). Bank activity and funding strategies: The impact on risk and return.
Journal of Financial Economics 98, 626-50.
Diamond, D. W. and R G Rajan (2000). A theory of bank capital. Journal of Finance 55, 2431-2465.
Diamond, D. W. and R G Rajan (2001). Liquidity risk, liquidity creation, and financial fragility: A theory of
banking. Journal of Political Economy 109, 287-327.
Diamond, D.W. and P.H.Dybvig (1983). Bank runs, deposit insurance, and liquidity. Journal of Political
Economy 91, 401-419.
Diamond, D.W., and P.H.Dybvig (1986).Banking theory, deposit insurance and bank capital regulation. Journal
of Business 59, 55-67.
Diamond, Douglas, and R G Rajan (2011). Fear of Fire Sales, Illiquidity Seeking and Credit Freezes. Quarterly
Journal of Economics 126, 557-91.
Federico, P., and F.Vazquez (2012). Bank funding structure and risk: Evidence from the global financial crisis.
IMF Working Paper 29, IMF: Washington DC.
Gale D., and T. Yorulmazer (2013). Liquidity hoarding, Theoretical Economics 8, 291–324.
Ghosh, S., D.M.Nachane, A.Narain and S.Sahoo (2003). Capital requirements and bank behaviour: An empirical
analysis of Indian public sector banks. Journal of international Development 15, 145-156.
Gorton, G. and A. Winton (2000). Liquidity provision, bank capital, and the macroeconomy. University of
Minnesota, Working Paper.
Heid, F., D.Porath and S.Stolz (2004). Does capital regulation matter for bank behaviour? Evidence for German
savings bank. Deutsche Bundesbank Discussion Paper 3, Bundesbank: Bonn.
Horvath, R., S. Jakub and L Weill (2012). Bank capital and liquidity creation: Granger causality evidence,
Working Paper, Charles University in Prague.
Huang, R. (2010). How committed are bank lines of credit? Experiences in the subprime mortgage crisis.
Federal Reserve Bank of Philadelphia Working Paper No. 25, Philadelphia: PA.
Hughes, J. P., W. Lang, L. J. Mester and C-G Moon (1994). Recovering technologies that account for generalized
managerial preferences: An application to non-risk-neutral banks. Working Paper 21, Department of
Economics, Rutgers University.
Imbierowicz, B. and C Rauch (2012). The Relationship between Liquidity Risk and Credit Risk in Banks,
Working Paper, April 11, SSRN.
International Monetary Fund (2010a). Impact of the global financial crisis on the Gulf Cooperation Countries
and challenges ahead. IMF: Washington DC.
International Monetary Fund (2010b). Regional Economic Outlook - Middle East and Central Asia (April). IMF:
Washington DC.
International Monetary Fund (2011a). Global Financial Stability Report (April). IMF: Washington DC.
International Monetary Fund (2011b). Regional Economic Outlook - Middle East and Central Asia (April). IMF:
Washington DC.
International Monetary Fund (2013). Regional Economic Outlook - Middle East and Central Asia (November).
IMF: Washington DC.
International Monetary Fund. Country pages. Available at <www.imf/org/external/country>
Ivashina, V. and D. Scharfstein (2010). Bank lending during the financial crisis of 2008. Journal of Financial
Economics 97, 319-38.
Jacques, K. and P. Nigro (1997). Risk-based capital, portfolio risk, and bank capital: A simultaneous equations
approach. Journal of Economics and Business 49, 533-547.
Jan Willem, van den End and M Tabbae (2012). When liquidity risk becomes a systemic issue: Empirical
evidence of bank behavior, Journal of Financial Stability 8, 107– 120.
Jokipii, T. and A.Milne (2011). Bank capital buffer and risk adjustment decisions. Journal of Financial Stability
7, 165-178.
Karim, M., S-G. Chan and S.Hassan (2010). Bank efficiency and non-performing loans: Evidence from Malaysia
and Singapore. Prague Economic Papers 2, 118-32.
Kim, D. and A.M. Santomero (1988), Risk in banking and capital regulation. Journal of Finance 43, 1219-23.
Koehn, M. and A.M. Santomero (1980). Regulation of bank capital and portfolio risk. Journal of Finance 35,
1235-1244.

19
Kwan, S and R.A.Eisenbis (1997). Bank risk, capitalization and operating efficiency. Journal of Financial
Services Research 12, 117-131.
Lindquist, K. (2004). Banks’ buffer capital: How important is risk? Journal of International Money and Finance
23, 493-513.
Lown Cara and D. Morgan (2006). The Credit Cycle and the Business Cycle: New Findings Using the Loan
Officer Opinion Survey. Journal of Money, Credit and Banking 38, 1575-97.
Martin Antoine, James McAndrews and David Skeie (2011). A Note on Bank Lending in Times of Large Bank
Reserves” Federal Reserve Bank of New York Staff Report No. 497.
Naceur, B S and M.E Kandil (2013). Has the Basel capital requirement caused credit crunch in the MENA
region? Middle East Development Journal 5, 14-30.
Nier, E. and U. Baumann (2006). Market discipline, disclosure and moral hazard in banking. Journal of
Financial Intermediation 15, 332-361.
Pasiouras, F., and K.Kosmidou (2007). Factors influencing the profitability of domestic and foreign commercial
banks in the European Union. Research in International Business and Finance 21, 222-37.
Peek, J., and E.Rosengren (1995). Bank lending and the transmission of monetary policy. Paper presented at
the Conference at Federal Reserve Bank of Boston.
Petersen, M. A., Rajan, R. G., 1995. The effect of credit market competition on lending relationships. Quarterly
Journal of Economics 110, 407-443.
Repullo, R., 2004. Capital requirements, market power, and risk taking in banking. Journal of Financial
Intermediation 13, 156-182.
Rime, B. (2001). Capital requirements and bank behaviour: Empirical evidence for Switzerland. Journal of
Banking and Finance 25, 789-805.
Salas, V and J.Saurina (2002). Credit risk in two institutional regimes: Spanish commercial and savings banks.
Journal of Financial Services Research 22, 203-24.
Santos, J.A.C. (2011). Bank corporate loan pricing following the subprime crisis. Review of Financial Studies
24, 116-43.
Scharfstein, D. and J. Stein (1990), Herd behavior and investment. American Economic Review 80, 465-479.
Shrieves, R.E. and D. Dahl (1992). The relationship between risk and capital in commercial banks. Journal of
Banking and Finance 16, 439-457.
Stiroh, K.J. (2004). Diversification in banking: Is non-interest income the answer? Journal of Money, Credit, and
Banking 36, 853-882.
Stolz, S. (2007). Bank capital and risk taking. Springer: Heidelberg.
Stolz, S., and M.Wedow (2011). Banks' regulatory capital buffer and the business cycle: Evidence for Germany.
Journal of Financial Stability 7, 98-110.
Strahan, Philip (2008), Liquidity Production in 21st Century Banking. NBER Working Paper No 13798,
Cambridge: MA.
Van Roy, P. (2008). Capital requirements and bank behavior in the early 1990s: Cross country evidence.
International Journal of Central Banking 4, 29-60.
Von Thadden, E.-L. (2004). Bank Capital Adequacy Regulation under the New Basel Accord. Journal of
Financial Intermediation 13, 90-95.
Wolman, A. and H. Ennis (2011. Large Excess Reserves in the U.S.: A View from the Cross-Section of Banks.
Federal Reserve Bank of Richmond, Manuscript.
Yilmaz, D. (2009). Islamic finance – during and after the global financial crisis. Address delivered at the
“Conference on Islamic finance – during and after the global financial crisis”, IMF-World Bank Annual
meetings, Istanbul. Available at <www.bis. org/review/r091013c.pdf>

20
 Table 1: Key financial ratios by country
Country Capital adequacy NPLs Liquidity ratio 3-bank concentration Bank asset/
ratio GDP
2006 2012 2006 2012 2006 2012 2006 2012 2006 2012
Bahrain 22.0 19.3 4.8 5.8 33.8 24.9 0.819 0.891 58 102
Kuwait 21.2 18.0 3.9 5.2 29.3 19.9 0.694 0.901 53 58
Oman 17.2 16.0 4.9 2.2 33 28 0.833 0.736 31 44
Qatar 14.3 18.9 2.2 1.7 8.9 18.5 0.884 0.876 41 70
Saudi Arabia 21.9 18.7 2.0 1.9 34 13.0 0.525 0.565 46 50
UAE 16.6 20.6 6.3 8.7 16.4 18.6 0.441 0.612 68 81
Source: Respective central bank websites, IMF (country studies) and Regional economic outlooks, IMF and World Bank

Table 2: Composition of banks by country

Banks

Country Total Conventional Islamic Listed Avg. no. of years of Total

observations observations
Bahrain 31 11 20 11 7.8 243
Kuwait 15 6 9 14 9.3 139
Oman 6 6 0 5 13.3 80
Qatar 10 7 3 8 11.5 115
Saudi Arabia 13 9 4 11 13.2 172
UAE 28 18 10 21 11.3 316
Total 103 57 46 70 10.3 1065

Table 3: Variable definition and summary statistics

Variable Definition Mean p.25 p.75
(SD)
Dependent variables
Credit risk NPL/Total loans 0.036 0 0.041
(0.079)

21
BUF (Actual CRAR – regulatory minimum CRAR)/regulatory 1.160 0.440 1.330
minimum CRAR (1.617)
SBUF BUF/ Std. dev (Actual CRAR) 13.576 5.430 17.080
(12.055)
NSFR Computed akin to Vazquez and Federico (2012) 1.606 0.966 1.420
(3.053)
Control variables
Size Log (total asset) 6.475 6.027 6.995
(0.685)
RoA Profit/Total asset 0.019 0.013 0.028
(0.058)
Loans Loans/Total asset 0.515 0.403 0.658
(0.210)
Funding Short-term funding/Total asset 0.144 0.031 0.207
(0.154)
Cost/Income Cost-to-income ratio 0.300 0.000 0.432
(0.481)
Divers Index of income diversification, defined following 0.364 0.306 0.465
2
Stiroh (2004) as 1- ( SH NET  SH NON
2
), (0.131)

NET NON
SH NET  SH NON 
NET  NON NET  NON
NET=net interest income; NON=non interest income
Core deposits/ Asset (Total customer deposits - current customer 0.387 0.00 0.655
deposits)/ Total assets (0.330)
Illiquid assets (Total assets - liquid assets)/Total assets 0.993 0.676 0.995
(1.955)
Securities gain (+)/ Net gains (losses) on trading and derivatives/ 0.002 0.00 0.002
loss (-) Total assets (0.005)
Loan loss reserves Loan loss reserves/ Total asset 0.036 0.013 0.043
(0.045)
MREG Dummy=1 if a bank is listed, else zero 0.679 0 1
(0.467)
Islamic Dummy=1 if a bank is Islamic, else zero 0.447 0 1
(0.497)
Crisis Dummy=1 for 2009, else zero 0.061 0 1
(0.239)

Table 4: Univariate tests of differences across bank characteristics

Full sample Conventional banks Islamic banks Differences Listed banks Unlisted banks Differences
in mean in mean
Panel A: Entire period Mean SD Mean SD Mean SD (t-test) Mean SD Mean SD (t-test)

NPL/Loans 0.036 0.079 0.056 0.087 0.012 0.061 11.945*** 0.046 0.088 0.017 0.047 8.653***
BUF 1.160 1.617 0.933 0.741 2.039 3.112 -4.352*** 0.984 1.184 1.824 2.583 -3.940***
SBUF 13.577 12.055 14.256 12.826 10.861 7.737 4.095*** 14.097 12.853 12.548 7.951 3.038***
NSFR 0.475 0.322 0.554 0.229 0.302 0.416 10.413*** 0.531 0.269 0.291 0.403 -8.804***
Panel B: Non-crisis
NPL/Loans 0.036 0.076 0.057 0.088 0.009 0.051 13.235*** 0.016 0.045 0.046 0.087 -8.878***

22
BUF 1.177 1.544 0.968 0.734 2.071 3.063 -3.991*** 1.768 2.351 1.028 1.221 3.513***
SBUF 14.267 12.273 14.955 12.976 11.219 7.823 4.126*** 11.752 8.084 14.881 13.027 -3.439***
NSFR 0.481 0.317 0.554 0.229 0.311 0.415 6.180*** 0.306 0.395 0.532 0.270 7.969***
Panel C: Crisis
NPL/Loans 0.040 0.101 0.033 0.051 0.049 0.141 -0.747 0.029 0.075 0.045 0.110 0.835
BUF 1.022 2.135 0.571 0.723 1.891 3.384 -2.003** 2.165 3.746 0.581 0.613 -1.973*
SBUF 7.762 7.983 7.046 8.307 9.193 7.234 -1.175 10.296 7.132 6.828 8.135 -1.832*
NSFR 0.416 0.364 0.556 0.232 0.242 0.422 4.496*** 0.186 0.452 0.516 0.264 -3.736***

23
 Table 5: 3SLS estimation of capital and risk
Model 1 Model 2
NPL BUF NSFR NPL SBUF NSFR
Endogenous

NPL -3.936 2.705 -42.731 14.471

(0.767)*** (0.542)*** (2.211)*** (4.489)***
BUF -0.036 1.067
(0.009)*** (0.192)***
SBUF -0.023 0.235
(0.003)*** (0.037)***
NSFR 0.027 0.813 0.089 3.482
(0.008)*** (0.221)*** (0.015)*** (1.198)***
Controls

Size -0.061 -1.048 1.322 -0.081 -3.511 0.699

(0.012)*** (0.125)*** (0.275)*** (0.020)*** (0.879)*** (0.220)***
RoA 7.474 -0.499
(1.412)*** (5.382)
Loans 0.484 0.882
(0.719) (3.593)
Funding 0.012 0.011
(0.021) (0.032)
Divers -0.022 -0.006
(0.025) (0.033)
Cost/Income 0.006 0.006
(0.010) (0.011)
Core deposit -0.249 0.012
(0.236) (0.245)
Illiquid asset 0.031 0.031
(0.089) (0.089)
Security gain 0.565 -0.679
(1.909) (1.057)
Loan loss reserve -2.112 -0.961
(0.091)*** (0.722)
Dummies

MREG 0.041 -0.005 -0.759 0.102 4.321 -1.087

(0.009)*** (0.132) (0.209)*** (0.023)*** (1.029)*** (0.243)***
Islamic -0.030 0.082 0.231 -0.101 -3.229 -0.954
(0.010)*** (0.148) (0.250) (0.025)*** (1.147)*** (0.253)***
Country*Year YES YES YES YES YES YES
Period 1996-2012 1996-2012 1996-2012 1996-2012 1996-2012 1996-2012
N.Obs 697 697 697 696 696 696
R-squared 0.469 0.206 0.498 0.595 0.355 0.568
Standard errors in brackets
***, *** and * denote statistical significance at 1, 5 and 10%, respectively

24
 Table 6: Determinants of liquidity hoarding
Variable Coefficient
Log Asset -0.136 (0.013)***
NPLs 1.643 (0.594)***
Core deposit -0.206 (0.212)
Security gain (+)/loss(-) -14.819 (12.269)
BUF 0.034 (0.056)
Observations 648
Country*Year Yes
Period 1996-2012
McFadden R-squared 0.187
Robust standard errors in brackets
***, ** and * denote statistical significance at 1, 5 and 10%, respectively

Table 7: Determinants of liquidity hoarding - Robustness

(1) (2) (3) (4) (5) (6)
LH -0.067 -0.062 -0.058
(0.009)*** (0.010)*** (0.011)***
LH*Crisis -0.091 -0.102
(0.011)*** (0.013)***
LH*Islamic -0.028
(0.023)
Predicted LH -0.569 -0.564 -0.521
(0.287)** (0.266)** (0.275)*
Predicted LH*Crisis -1.708 -1.720
(0.294)*** (0.299)***
Predicted LH*Islamic 0.012
(0.034)
Size -0.005 -0.005 -0.007 -0.018 -0.007 -0.008
(0.002)** (0.002)** (0.003)** (0.010)*** (0.003)** (0.002)***
BUF 0.009 0.009 0.009 0.015 0.012 0.012
(0.004)** (0.005)* (0.004)** (0.007)** (0.004)*** (0.004)***
NPL -0.383 -0.377 -0.376 -0.145 -0.127 -0.121
(0.181)** (0.176)*** (0.169)** (0.029)*** (0.065)** (0.073)*
Country*Year Yes Yes Yes Yes Yes Yes
Observations 681 681 681 634 634 634
Period 1996-2012 1996-2012 1996-2012 1996-2012 1996-2012 1996-2012
R-squared 0.4109 0.4144 0.4169 0.3617 0.4331 0.4334
Standard errors (clustered by bank and year) in brackets
***, ** and * denote statistical significance at 1, 5 and 10%, respectively

25