Factors affecting bank liquidity during times of crisis: Evidence from European countries

Type of the article: Research ArticleAbstractBank liquidity is a critical determinant of financial stability, particularly during periods of economic and geopolitical uncertainty. It is therefore a significant issue for both policymakers and financial institutions to understand the factors affecting bank liquidity in such circumstances. This study examines the main factors influencing the liquidity of European banks during three major crises: the Subprime crisis, the COVID-19 pandemic, and the Russian-Ukrainian war. The empirical analysis uses a dataset of 196 European banks observed from 2005 to 2022, employing Prais-Winsten regression models with panel-corrected standard errors (PCSE). Based on various liquidity measures, this study finds that both internal bank characteristics and external economic conditions influence liquidity, but their effects vary across crises. At the micro level, credit risk and loan loss reserves consistently have a negative impact on liquidity, which intensifies during the COVID-19 and Russia-Ukraine crises, reflecting banks’ increased vulnerability to loan impairments in periods of uncertainty and stress. Market risk has a positive effect on liquidity across all crises, highlighting the growing reliance on interbank markets during times of instability. Bank size consistently shows a negative relationship with liquidity across all crisis periods, indicating that larger banks tend to hold lower levels of liquid assets regardless of the nature of the crisis. Diversification modestly supports liquidity, while capital adequacy is negatively associated with liquidity, indicating a trade-off between capital and liquid asset holdings. At the macro level, inflation enhances asset liquidity but reduces short-term liquidity, whereas GDP growth contributes positively only to short-term liquidity.