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.