This study investigates the impact of banking system liquidity creation on monetary policy tools in Iran. Using panel data from 17 state-owned and private banks over the period 2008–2023 and applying the System Generalized Method of Moments (System GMM) approach, we find that higher reserve requirements reduce liquidity creation, whereas banks’ indebtedness to the central bank increases it. Market concentration negatively affects liquidity creation, while bank size, inflation, and economic growth exert positive effects. The results suggest that central bank policies, market structure, and macroeconomic conditions jointly influence banks’ capacity to create liquidity.
Purpose/Aims:
This study examines the impact of banking system liquidity creation on the effectiveness of monetary policy tools in Iran. It focuses on how banks’ financing structures, market concentration, and macroeconomic factors influence liquidity generation.
Methodology & Framework:
Using panel data from 17 active banks (state-owned and private) over the period 2008–2023, the System GMM was employed to estimate the dynamic effects of reserve requirements and banks’ indebtedness to the central bank on liquidity creation. Market concentration was measured using the Herfindahl–Hirschman Index (HHI).
Findings:
The results indicate that higher reserve requirements reduce banks’ liquidity creation, whereas greater indebtedness to the central bank increases it. Market concentration has a negative effect on liquidity creation. Inflation, economic growth, and bank size positively influence liquidity generation, while exchange rate fluctuations exert a negative effect.
Discussion:
Banks with diversified financing structures exhibit lower sensitivity to central bank policies. Larger banks are able to generate more liquidity due to greater financial resources. The policy implications suggest that maintaining balanced reserve ratios, reducing market concentration, stabilizing exchange rates, and closely monitoring macroeconomic conditions can enhance banks’ ability to create liquidity.
Conclusion & Implications:
This study demonstrates that central bank monetary policy tools significantly influence banks’ liquidity creation. The legal reserve ratio reduces liquidity by limiting banks’ resources available for lending and investment, whereas banks’ debt to the central bank positively affects liquidity, as banks rely on central bank facilities to meet their funding needs. Market concentration, measured by the  HHI, negatively impacts liquidity creation, as highly concentrated markets limit competition and reduce banks’ capacity to extend loans and diversify financial products.
Macroeconomic factors such as inflation and economic growth also play important roles. Inflation and economic growth enhance liquidity creation by increasing loan demand, deposit mobilization, and banks’ financial capacity. Larger banks are better able to generate liquidity due to greater capital strength and access to funding facilities, whereas exchange rate volatility has a negative effect by increasing economic uncertainty and financing costs.
The policy implications suggest that the central bank should actively monitor banks’ indebtedness, maintain balanced reserve ratios, and implement measures to reduce market concentration and promote competition. Controlling inflation and stabilizing exchange rates can further support banks’ capacity to create liquidity. Overall, effective liquidity creation depends on the interaction among monetary policy, banking market structure, and macroeconomic conditions.