This paper investigates how bond market development will shape bank portfolio structures and liquidity risk exposure. Exploiting a bank-level dataset that covers 447 banks from 26 emerging markets during 2006 to 2017, we find that bond market development significantly reduces risks in banks’ asset and deposit portfolios and strengthens bank liquidity position. In particular, government bond market serves as a source of liquid assets while corporate bond market works as alternative source of stable funding in contributing to bank stability and strengthening bank balance sheet. Moreover, larger bond market facilitates big and well-capitalized banks to take risk while maintain resilience to liquidity shocks. Overall, bond market development does not harm banking sector’s role in liquidity creation, in the contrary, it offers banks greater scope in liquidity risk management. This study presents the first direct evidence to show how a wellfunctioning bond market enhances banking stability, offering policy implications that a diversified capital market complements banking sector as a good source of liquid assets, risk management tools and long-term equity and debt financing. 

Key words: bond market development, liquidity risk, portfolio structure, financial stability
JEL code: G10, G18, G21, G28​