Assessment of Liquidity Creation in the Canadian Banking System

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Liquidity creation is a fundamental function of banks. It provides the public with easy access to funds. These funds are important because they allow households and businesses to consume and invest. In this note, we measure liquidity creation by Canadian financial institutions from the first quarter of 2012 to the second quarter of 2019, using a methodology suggested by Berger and Bouwman (2009) and known as the BB measure. Our assessment shows that the Canadian banking sector created liquidity steadily from 2012 to 2015, stabilizing in 2016 through the second quarter of 2019. Over this period, liquidity creation was mainly driven by two sets of movements on banks’ balance sheets: decreases in illiquid liabilities and increases in liquid liabilities such as bank deposits. Liquidity creation is important for supporting economic growth, but it may have financial stability implications if banks engage in high levels of liquidity creation. Therefore, it is important to monitor this balancing act between the benefits and costs of liquidity creation to predict and perhaps lessen risk to the financial system. To facilitate this, we suggest using the BB measure as a tool. By monitoring the movements on banks’ balance sheets, we can observe the changes in banks’ liquidity creation over time.