Economic Policy Uncertainty and Liquidity Hoarding: Econometric Analysis for Indian Banks

Abstract

The present study investigates the impact of economic policy uncertainty (EPU) at the national and global levels on a comprehensive measure of bank intermediation, that is, liquidity hoarding (LH) of Indian banks during the 2005 to 2020 period. The findings of the Driscoll–Kraay non-parametric estimator show that Indian banks tend to hoard liquidity in times of economic uncertainty. As per the spillover effects, banks having higher peer LH tend to hoard more liquidity during times of uncertainty compared to lower peer-hoarding banks. Furthermore, the heterogeneity analysis documents that the magnitude of EPU is more destructive for bigger banks, banks with lesser capital bases and liquidity, higher credit risk and public sector banks. Our sensitivity analysis reveals that greater LH is caused by the balance sheet and bank lending channels of credit channel theory. Finally, the study shows that it is imperative to cultivate the growth of financial markets and institutions that can adjust to evolving economic circumstances to lessen the negative effects of EPU.