Banks' liquidity holdings are comfortably above legal or prudential requirements in most Central American countries. While good for financial stability, high liquidity may nonetheless hinder financial market development and monetary policy transmission. Using a panel of 96 commercial banks from Central America, Panama and the Dominican Republic for 2006-2010, we find that the demand for precautionary liquidity buffers is associated with measures of bank size, profitability, capitalization, and financial development. Higher liquidity is also associated with deposit dollarization, reinforcing the monetary policy and market development challenges in highly dollarized economies. This is one of the first empirical studies to investigate the relation between degrees of dollarization and bank liquidity holdings. Its findings suggest that improvements in supervision and measures to promote dedollarization, including developing local currency capital markets, would help enhance financial systems' efficiency and promote intermediation in the region. [ABSTRACT FROM AUTHOR]