Asset-Liability Dependency: Evidence from a Sample of European Commercial Banks

A recent strand of literature emphasizes a scope economy between bank funding and lending, which is related to the banks’ role of liquidity providers. These papers find that the presence of demand deposits can “naturally” hedge the liquidity risk stemming from unused loan commitments [Kashyap et al. (2002), Gatev and Strahan (2006), Gatev et al. (2009)]. Their results support the theoretical argument that, by exposing themselves to asset-side and liability-side liquidity risks simultaneously, banks can enjoy a risk-reducing synergy, and explain the positive correlation across banks between demand deposits and loan commitments. This paper aims at providing a measure of asset-liability dependency for a sample of European banks through the application of the canonical correlation analysis [see De Young and Yom (2008), Simonson et al. (1983),and Fraser et al. (1974) for applications of this technique within the U.S. banking system]. By using canonical correlation we can infer which assets banks match with which liabilities in asset-liability management. Furthermore, canonical correlation is a very flexible tool because it doesn’t require any particular structure on the data and any assumptions about the casual direction between assets and liabilities. We show how the relationships between asset and liability accounts at European commercial banks changed between 1999 and 2007. We find that the developments that the European banking systems have gone through have permitted banks to operate with weaker balance sheet constraints. Finally, we discuss the implications stemming from the evidence we provide from a risk management perspective.