The purpose of this study is to examine the nonlinear relationship between institutional quality and bank liquidity creation and to analyze whether the impact of institutional quality on liquidity creation depends on the level of institutional quality or not.
This study is based on a sample of 126 Middle East/North Africa (MENA) region banks for the period extending from 2006 to 2020. To deal with the nonlinearity, we apply a dynamic panel threshold method.
Using six different indicators of institutional quality, the results reveal that the impact of the institutional quality on liquidity creation depends on the level and the indicator of institutional quality. While control of corruption, government effectiveness and regulatory quality have positive (negative) effects below (above) the threshold value, political stability has a positive impact below and above the threshold value. Regarding the role of law and voice and accounting, only significant negative impact above the threshold value is found.
The research findings have important implications for policymaking. It suggests that institutional quality may have the potential to reduce liquidity creation rather than increase it. As a result, policymakers should work on providing an optimal level of institutional quality that promotes bank liquidity creation as a means to stimulate economic growth.
This paper is among the first studies, to the best of the authors’ knowledge, to examine the nonlinear relationship between institutional quality and bank liquidity creation using a dynamic panel threshold model.
