Stock market liquidity and traditional sources of bank business

With enhanced financial liberalisation, banks’ reliance on traditional intermediary functions has gradually declined, changing the risk profile of these systemically important financial institutions. This paper examines an important channel through which these changes occur, the spillover effects from an increase in stock market liquidity on traditional bank business. This is the first paper to provide empirical evidence of a decline in the value of bank deposits and loans as aggregate stock market liquidity increases, with data from 7,297 banks in 39 countries from 1999 to 2014. We find that such effects vary with the level of financial development in the country and with the level of investor protection. These findings provide information for policy-makers to better understand important spillover effects of policy changes designed to enhance stock market liquidity.