Unexpected Deposit Flows, Off-Balance Sheet Funding Liquidity Risk and Bank Loan Production

Abstract

In this paper, we use U.S. commercial banks' data to investigate whether the effect of unexpected deposit flows on loan production depends on banks' exposure to off-balance sheet funding liquidity risk. We find that lending is sensitive to deposit shocks at small banks but not at large ones. Furthermore, for small banks, the increase in lending explained by unexpected deposit inflows depends on how much they are exposed to funding liquidity risk stemming from their off-balance sheets, as measured by the level of unused commitments. Small banks more exposed to such funding liquidity risk tend to extend fewer new loans. Our results indicate that unexpected deposit inflows from, for instance, the failure of other banks or market disruptions might not as easily be fueled again to borrowers.

Keywords: unexpected deposit flows, loan production, off-balance sheet funding liquidity risk

JEL Classification: G21, G28