Bank capital, risk and liquidity creation

This dissertation contains three chapters on bank capital. Chapter 1 provides a brief overview of the dissertation.; Chapter 2 theoretically and empirically examines how three corporate governance mechanisms---bank capital, regulatory monitoring and large shareholder monitoring---affect an acquiring bank's post-acquisition risk taking and performance. My model predicts that regulatory monitoring will be less stringent for high-capital acquirers than for low-capital acquirers and that as a result, high-capital acquirers will engage in acquisitions that underperform those of low-capital acquirers and increase risk more. Moreover, my model predicts that the presence of a large shareholder mitigates this effect: high-capital acquirers with a large shareholder should perform better than high-capital acquirers without a large shareholder. I test these predictions by examining the increased risk taking and long-run abnormal stock and accounting performance of acquirers. The results support my model.; Chapter 3 analyzes the relationship between bank capital and liquidity creation. Recent theory papers by Diamond and Rajan (2000, 2001) and others suggest that banks with higher capital ratios may create less liquidity because capital diminishes financial fragility and/or "crowds out" deposits. Other contributions suggest the opposite outcome: banks with higher capital ratios may create more liquidity because capital gives them greater capacity to absorb the risks associated with liquidity creation. We construct liquidity creation measures for U.S. banks from 1993--2003 and test these opposing theoretical predictions. Our calculations suggest that the industry created over {dollar}1.5 trillion in liquidity as of year-end 2003, and this amount has grown over time. For large banks, which account for most of the industry's assets, we find a statistically significant positive relationship between capital and liquidity creation. For small banks, which comprise the vast majority of the observations, the relationship is significantly negative. Simulation of 1 percentage point higher lagged capital ratios for all banks yields a predicted greater aggregate liquidity creation of 2.0% ({dollar}30.6 billion), as the positive effect for large banks overwhelms the negative effect for small banks. However, the positive effect at the industry level may be eliminated under alternative assumptions.