Liquidity Holdings, Diversification, and Aggregate Shocks

Abstract

This paper shows that US banks’ increased geographic diversification is an important explanation for the decline of their liquidity buffers from 1976 to the 2008 crisis. Diversified banks also hold more illiquid small business loans, less liquid mortgages, and have higher net liquidity creation. During the crisis, however, better diversified banks hoard more liquidity. These results suggest that diversification increases liquidity risk-taking capacity in normal times, and that exploiting this advantage leaves banks more exposed to aggregate shocks.