Economic Policy Uncertainty and Bank Liquidity Creation

Using over one million observations, we identify an important channel through which economic policy uncertainty (EPU) harms the real economy – bank liquidity hoarding. Our novel comprehensive measure of bank liquidity hoarding (LH(total)) takes into account hoarding on the asset-, liability-, and off-balance sheet-sides. We find in response to EPU, banks hoard liquidity overall and through all three components. Identification analyses find that these effects are primarily from bank supply/demand choices, rather than customer choices, suggesting causal adverse effects on the real economy. Our results may help explain prior literature findings of unfavorable effects of uncertainty on firm and household behavior.