Bank Heterogeneity and Capital Allocation: Evidence from 'Fracking' Shocks

Abstract

This paper empirically investigates banks’ investment allocations over the recent business cycle. By exploiting unconventional energy development, I identify unsolicited deposit shocks and estimate banks’ allocation of these deposits. In the pre-recession period, banks lend 38% of incremental deposits; however, during the downturn banks favor liquid assets and lending allocations fall to 22%. Banks with low risk tolerance and less access to liquidity are particularly sensitive to the decline in economic conditions, choosing securities and cash, respectively. The findings identify significant heterogeneity in the willingness of banks to allocate capital during adverse times.

Keywords: banks, natural experiment, liquidity, shock, risk

JEL Classification: G21