Bank diversification and liquidity creation: Panel Granger-causality evidence from China

This paper applies the empirical methodology of panel Granger-causality tests to test the relationship between bank diversification and liquidity creation, employing the panel vector autoregression models in a generalized method of moments framework. We find that an increase in the degree of bank diversification between traditional bank activities generating net interest income and non-traditional bank activities generating non-interest income reduces bank liquidity creation. However, an increase in the degree of bank diversification within non-traditional bank activities leads to an increase in bank liquidity creation. In the context of China's banking sector, the positive and negative aspects of bank diversification coexist. In addition, we do not find evidence of reverse causality between banks' diversification and liquidity creation. Furthermore, we examine whether the investigated empirical relationship will change for heterogeneous banks and find that the relationship between bank diversification and liquidity creation exhibits heterogeneity for banks with various characteristics.