This paper aims to evaluate the relationship between capital and liquidity following the implementation of the Basel III rules. These regulatory measures target both increased capital ratios and a reduction of banks’ maturity transformation risk , which could result in excessive constraints on bank liquidity creation, thereby negatively affecting economic growth. Using a simultaneous equation model, we find a bi-causal negative relationship, which suggests that banks may reduce liquidity creation as capital increases; and when liquidity creation increases, banks reduce capital ratios. Our results therefore imply a trade-off between financial stability (higher capital, reduced risk) and economic growth (liquidity creation)
