Market power and liquidity creation: Size heterogeneity and risk absorption

Abstract

This study examines the relationship between market power and liquidity creation in Vietnam, focusing on whether this relationship varies across bank size classes. Using an unbalanced panel of 28 Vietnamese commercial banks over the period 2008 - 2024, we measure liquidity creation following the methodology of Berger and Bouwman (2009) and capture bank-level market power through the Lerner index derived from a translog cost function. Because the Lerner index is an inverse measure of competition (higher values indicate greater market power), we frame hypotheses and interpret coefficient signs in terms of market power throughout. Employing the dynamic generalized method of moments (GMM) estimation, we first establish the baseline effect of market power on liquidity creation, then test whether bank size moderates this relationship. The results confirm that market power has a positive and significant effect on liquidity creation, consistent with the risk absorption hypothesis. The interaction term between market power and the large-bank dummy is positive and significant, indicating that the positive effect of market power on liquidity creation is approximately 2.3 times stronger for large banks than for small banks. These findings carry policy implications for the State Bank of Vietnam regarding the design of competition policies that account for structural differences across bank size categories.