Title: Non-performing assets, moral hazard and liquidity creation: evidence from Indian banks

Authors: Naina Grover; Pankaj Sinha

Addresses: Jindal Global Business School, O.P. Jindal Global University, Sonipat Narela Road, Near Jagdishpur Village, Sonipat, Haryana 131001, India ' Faculty of Management Studies, University of Delhi, Prof ND Kapoor Marg, Opp. Kirorimal College, Delhi School of Economics, University Enclave, New Delhi, Delhi 110007, India

Abstract: This study looks into the incidence of the moral hazard hypothesis in the Indian banks using the liquidity creation concept. Liquidity creation measure is considered to be more inclusive and comprehensive in measuring the risk-taking of a bank. The study uses data from 2005 to 2019 extracted from the database of the Reserve Bank of India. A fixed-effect model with Driscoll and Kraay standard errors and system GMM is deployed to ascertain the association between liquidity creation and NPAs. This study determines a significantly positive relationship between NPAs and liquidity creation in public sector banks, but this relationship is not evident in private banks. This study testifies the moral hazard hypothesis in public sector bank. This study highlights the perils associated with the recent mergers in public sector banks and how 'too big to fail' might incentivise public banks to undertake more risks since there are already traces of the problem of moral hazard.

Keywords: India; liquidity creation; moral hazard; non-performing assets; NPA; off-balance sheet activities; scheduled commercial banks.

DOI: 10.1504/IJEPEE.2025.146768

International Journal of Economic Policy in Emerging Economies, 2025 Vol.21 No.4, pp.402 - 418

Received: 19 Nov 2020
Accepted: 18 Jul 2021
Published online: 17 Jun 2025 *

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