Liquidity Creation, Bank Competition and Revenue Diversification

Abstract

We examine the individual and joint effects of bank competition and revenue diversification on liquidity creation. We find that bank competition and revenue diversification have a positive impact on banks’ propensity to create liquidity. Competition appears to primarily impact on-balance-sheet liquidity creation while revenue diversification is a key driver of off-balance-sheet liquidity creation. When considered together, each has a moderating effect on the other in relation to liquidity creation suggesting a substitution effect between competition and revenue diversification. Such substitution effect, however, is found predominantly for small and medium banks and during crisis periods. Our findings suggest that policymakers and regulators should be cautious of a one-size-fits-all approach to bank competition and revenue diversification in promoting bank stability.