Bank Liquidity Creation, Loan Concentration & Liquidity Risk: A Perspective of Sri Lankan Licensed Commercial Banks

This research investigates the relationship between liquidity creation and liquidity risk in Licensed Commercial Banks (LCBs) in Sri Lanka, with a focus on the moderating role of loan concentration. The study is based on secondary data collected from the annual reports of 20 LCBs (2 public and 18 private banks) and Central Bank reports, covering the period from 2015 to 2023. The data, gathered annually, were analysed using panel regression correlation analysis techniques. The results show a strong positive relationship between liquidity creation and liquidity risk, meaning that banks are increasingly vulnerable to liquidity hazards as they generate more liquidity. Nevertheless, the investigation revealed that this link is not significantly moderated by loan concentration. This implies that the effect of liquidity creation on liquidity risk is independent of the distribution of loans within a bank's portfolio. The inability to obtain comprehensive data from certain institutions was one of the study's constraints, affecting the depth of the statistical analysis. Nevertheless, the finding has significant ramifications for Sri Lankan financial procedures. It highlights the necessity of efficient liquidity management techniques in the face of strict regulatory frameworks. The results are particularly relevant to bank treasury departments, enabling them to better understand the dynamics of liquidity creation and its associated risks. This study also contributes to the understanding of loan concentration’s role in liquidity risk management, providing insights that can guide both short-term and long-term strategic planning within the banking sector.