Does liquidity affect the financial health of Indian banks?

Abstract

The dynamic and volatile economic environment impacts the bank’s performance and raises the risk of bankruptcy. This study deepens the understanding of financial distress in the Indian banking sector through liquidity. Furthermore, the study aims to analyse and understand the relationship between liquidity, liquidity measures and financial distress. The study evaluated the short- and long-term liquidity ratios from 2012 to 2022. Quantile panel discussion analysis (QPDA) was incorporated into this study. Linear and non-linear relationships measure the impact of liquidity on financial distress. The study comprises data from 23 Indian banks and represents the Indian banking  landscape. The study investigates the effect of Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) on bank stability. The findings highlight that the LCR improves short-term liquidity   but excessive levels can increase bank distress. On the other hand, NSFR raises stress initially but improves stability and reduces distress beyond a certain limit. The results show the need to balance short-term liquidity with long-term funding stability in regulatory policies. The implications of this study contribute to risk management strategies and better decision-making within the baking sector. This study proposes significant insights to the banks, policymakers, regulators and various banking institutions.