This study strives to examine the relationship between bank capital and bank liquidity level considering the joint determination of both variables pointed out in the related literature. The evidence is from the Gulf Cooperation Council (GCC) countries: Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain and Oman. The theory of banking postulates that bank capital and bank liquidity are interrelated through various links. The study conjectures that large GCC banks do not have a concern with respect to liquidity due to the implicit guarantee of GCC wealthy governments to bank deposits.
The study sample is comprised of all chartered GCC conventional and Islamic banks. The study employs several on-balance sheet ratios to proxy for bank capital and liquidity as defined in the banking literature. It also employs a related econometric model that considers the simultaneity issue pointed out in the related literature.
The results of the study reveal that GCC banks react positively when facing illiquidity by strengthening their capital ratio. Further analysis reveals that only small GCC banks (conventional and Islamic) tend to increase their capital levels when facing a liquidity shortage, which confirms the study conjecture that larger GCC banks have no credible concern about their liquidity position. Employing an alternative measure of liquidity does not change the results. This finding supports the financial fragility structure and the crowding out of deposits hypotheses.
The study contributes to the literature by employing a novel estimation approach to explore the difference in results as the sample banks represent two banking regimes, the conventional banks as well as the Islamic banks. Also, the study implicitly suggests that further research in this area could support the need to impose minimum and globally uninformed liquidity standards on banks.
