Bank liquidity creation under micro uncertainty: The conditioning role of income structure

Abstract

This paper analyzes how uncertainty affects bank liquidity creation, particularly highlighting the conditioning role of income structures. Overall, there is limited research linking banks’ strategic activities with how they respond to uncertainty. We proxy micro uncertainty for the banking sector via the dispersion of bank-level shocks and measure liquidity creation by classifying and weighting all on- and off-balance sheet items. Using a panel of Vietnamese banks for 2007–2019, we find that uncertainty restrains banks from extending their liquidity creation. Further investigation reveals that the adverse impact of uncertainty on bank liquidity creation is alleviated when banks increase non-interest income or gain higher levels of income diversification. Besides, the effect of uncertainty and the role of income structures still hold when we replace liquidity creation with bank lending. Therefore, our results imply that revenue diversification could be encouraged to limit the detrimental impacts of uncertainty on bank output.