Bank Liquidity and Exposure to Industry Shocks

Abstract

This paper examines the link between bank liquidity and exposure to industry-level shocks. Using a unique dataset of borrower industry affiliations, we propose a new measure of industry-level shocks calculated at bank-level. First, we construct bank-specific loan portfolio weights for each industry. Then, we apply these weights to two industry-level indices – cost-effectiveness and production – to calculate the bank shock exposure. Our estimates reveal the negative link between bank liquidity and industry shocks. This could be explained by precautionary reasons as large negative industry-level shocks are likely to induce banks to hoard liquid assets. The relationship is also channelized through the lending behavior of banks. The sensitivity of liquidity to bank exposure is higher for more liquid, better capitalized and smaller banks, which might be explained by the capability of displacing funds either for precautionary reasons, or for loan financing.