Standard Control Variables

Deposit volatility: Liquidity preference of banks was affected by the public expectations formation. This was found to be related with excess liquidity. Agenor et al. (2004) found this as one of the main factors that could explain the excess liquidity problem for the economy of Thailand. Larsen (1951) also identified this as a probable reason for excess liquidity. According to him, liquidity preference of banks was affected by public expectations. To analyse demand for liquidity of banks, volatility of depositors’ cash preference should thus be taken into consideration. Saxegaard (2006) observed that currency withdrawal volatility, which was very similar to deposit volatility, could influence excess liquidity situation. From Bankscope, the data of total deposits or total customer deposits could represent the concept of deposit. These measures could also represent concepts like excess savings (that was used by Gu and Zhang, 2006; Wang, 2006; McKinnon, 2006, 2007; Han and Chen, 2007; Roubini, 2007; Xia and Chen, 2007; Zheng and Yi, 2007; Chen, 2008) and low consumer spending (which was used by Qing, 2006; Jiao and Ma, 2007). Moreover, deposit volatility also represented the liquidity risk (Agenor et al., 2004) since the volatility of deposit might force banks to keep more liquid assets than required due to the uncertainty involved.

In this study, the volatility of deposit was measured by a 3-year period standard deviation of total deposit using the overlapping method. Reason for choosing the 3-year period was the short span of data availability as the maximum period of available data for each bank was 15 years. Through this

way, two observations were lost but still there were generally a series of 13 years of data for each bank.

Deposit rate: The deposit rate could affect the excess liquidity situation of the banks. If the deposit rate was high, people would be more interested in keeping their money in banks. Assuming everything else constant, this would lead to higher level of excess liquidity in the banking sector. Hence, it could be assumed that the deposit rate would be positively related with the excess liquidity situation of the banking sector. From Bankscope, the ratio of interest expense on customer deposits as a ratio of average customer deposits was taken to measure this variable.

Impaired loans: One possible reason of high impaired loans was risky environment. If banks faced problem of loan default, then they would be less encouraged towards lending which will lead towards less allocation of credit. Hence, the amount of impaired loans could lead to higher excess liquidity. Impaired loans as a ratio of gross loans data from Bankscope was taken to measure this determinant. This measure might also represent factors like weak contract enforcement and rule of law as well as imprudent lending.

Government bills and bonds: As discussed earlier, out of the total required reserve for each bank, some part was needed to be kept in cash. This was called the CRR. The rest could be put in cash or in government bills or bonds. Since these were risk free, so there was a tendency of banks to put part of their reserves in the government bills and bonds rather than opting for lending as that involved risk of default. The rate of these bills and bonds and their difference with the lending rate played a significant role on how much would be invested on these as well as the direction and significance of the relationship.

In this respect, the spread between the treasury bill rate and the lending rate was applied to see how it affected the excess liquidity situation. This measure involved both the rates that banks consider and decide whether to

invest or keep as liquid assets. Treasury bill rate for the 91-day bills was used to represent the government bills and bonds. Then the lending rate was deducted from this rate for each individual bank. The lending rate was proxied by the ‘interest income/ average earning assets (%)’ measure from Bankscope.

Lagged dependent variable: The lag of excess liquidity was used in some of the earlier studies of excess liquidity (e.g. Agenor et al., 2004; Saxegaard, 2006; Aikaeli, 2011). The reason for using this as one of the explanatory variables was that it takes into account both the contemporaneous and the lagged effects. Another argument for its inclusion was that the adjustments were unlikely to be instantaneous. Hence, one-year lag values of the dependent variable were taken as one of the explanatory variables.

Some other variables: Some variables that were used in earlier studies but not included in this work due to their similarity with one of the independent variables or the dependent variable are described here. The rate of required reserve was observed as one of the important variables in earlier studies. However, since the dependent variable in its definition deducts the mandatory reserve, hence the required reserve variable was not included as one of the explanatory variables. The concepts of ‘excess savings’, ‘low consumer spending’ and ‘liquidity risk’ could be measured by the same measure of ‘deposit volatility’ concept while the concept of ‘weak credit growth in relation to domestic deposit growth’ was very close to the concept of excess liquidity. Since deposit rate was used as an explanatory variable and lending rate was used to measure the spread from the treasury bill rate, so the ‘lending rate’ and ‘interest rate spread’ were not used separately. Different external factors like ‘foreign reserve’, ‘export’, ‘foreign aid’, ‘oil revenue’, ‘foreign direct investment’, ‘exchange rate’ and ‘remittance’ were described important in different earlier studies (e.g. Gilmour, 2005; IMF, 2005; Khemraj, 2006; Qing, 2006; Saxegaard, 2006; Jiao and Ma, 2007; Ma 2007; Bakani, 2012). At bank-level several of these are irrelevant. One measure that might be able to proxy

the variable of exchange rate was deposit rate since central bank could enforce a higher deposit rate for each bank to protect the economy from a weak exchange rate. Since deposit rate was used as one of the explanatory variables, exchange rate was not separately included in this study.