Liquidity Creation and Trust Environment

Trust towards banks plays a central role in theoretical literature. Diamond and Dybvig (J Polit Econ 91:401–419, 1983) argue that in a trustworthy environment banks can easily collect deposit foster banking activity and asset transformation. Diamond and Rajan (J Polit Econ 109:287–327, 2001) posit that a high trust environment discourages banks from creating liquidity. To address these conflicting views, the current study measures liquidity creation using Berger and Bouwman’s (Rev Financ Stud 22:3779–3837, 2009) methodology, then assesses the level of trust in the environment with four proxies and two additional instruments deployed in previous research. The results confirm a positive effect of trust in banks on liquidity creation, especially for small or state-chartered banks and during economic downturns. The results are robust to time effects and potential endogeneity concerns.