How do banks determine their spreads under credit and liquidity risks during business cycles?

This paper investigates the impact of credit and liquidity risks on banks’ spreads during business cycles in an emerging market using a novel data from January of 2002 to December of 2013. The estimation results highlight the importance of these risks in determining bank spreads. Overall, credit risk is more important than liquidity risk in explaining bank spreads. However, their impacts on spreads differ over business cycles. Specifically, while liquidity risk has a more significant impact on spreads during recessions, credit risk has a more significant impact during economic booms. These findings are consistent with the recent policy measures taken by the regulatory authorities in Turkey.