THE RELATIONSHIP BETWEEN LIQUIDITY CREATION AND DIVERSIFICATION IN BANKING: A COMPREHENSIVE LITERATURE REVIEW

Abstract:This study presents a structured literature review exploring the relationship between liquidity creation and diversification in the banking sector. As banks increasingly adopt diversification strategies—whether in income sources, funding channels, or asset portfolios—to improve performance and resilience, understanding how these strategies influence liquidity creation becomes critically important. While diversification is often associated with enhanced financial stability, its effects on banks’ ability to generate liquidity remain inconclusive. This paper synthesizes theoretical frameworks and empirical findings to offer a comprehensive analysis of this complex relationship. In contrast to previous studies that examine diversification or liquidity creation in isolation, this review bridges both areas by drawing on a wide range of academic works, all of which are exclusively referenced from the submitted thesis. The findings suggest that while moderate diversification may support liquidity provision by reducing income volatility and funding risk, excessive diversification can increase operational complexity and systemic vulnerability, thereby weakening liquidity buffers. The review concludes by identifying key gaps in the existing literature and proposing directions for future research to clarify and expand upon these dynamics.

 

Keywords: : Liquidity Creation, Diversification, Financial Institutions