Relationship between liquidity creation and diversification in banking-Turkish banking sector application-

According to the modern financial intermediation theory, banks play two important roles in the economy: liquidity creation and risk transformation. The primary role of banks is to create liquidity by converting illiquid assets into liquid liabilities. Since the bank's liabilities are more liquid than its assets, creating a liquidity mismatch, the bank is exposed to liquidity risk. The second role of banks is to transform risks by financing risky loans with riskless deposits. The basis of the liquidity creation role of banks as financial intermediaries dates back to Adam Smith's book "Wealth of Nations" written in 1776. In the study, effects of income diversification on liquidity creation and thus liquidity risk is examined by bringing together the theories of diversification and liquidity creation in banking. By following the liquidity creation measurement methodology of Berger and Bouwman (2009), Turkish Banking Sector's liquidity creation and liquidity risk is measured. Then, the relation between the income diversification levels of the banks and the liquidity risk is presented. Covering period of 2006-2020, within the scope of the hypothesis of the study it is observed that there is a negative, significant relationship between income diversification and liquidity creation in medium-sized and domestic banks. In addition, another important finding of the study is that the relationship between bank capital and bank liquidity creation differs according to bank size.