The double-edged effect of bank liquidity creation efficiency on systemic risk: Evidence from China

Bank liquidity creation fosters economic growth while entailing liquidity mismatch risk. This study explores whether improving bank efficiency during liquidity creation can mitigate systemic risks. We propose a bank liquidity creation efficiency measure based on a stochastic frontier approach to analyze Chinese commercial listed banks from 2000-2021. Through systemic risk decomposition, we find that higher profit efficiency alleviates individual tail risk but strengthens system linkage for Chinese banks, representing a double-edged effect. Further analysis reveals that high profit efficiency is associated with more investment in real estate and higher risk-taking on loans. Banks' digital transformation can help alleviate the dilemma of being too connected to the system. The results provide implications for emerging markets to prevent risk and promote economic growth.