Passing Through? Bank Entry and the Deposits Channel

Abstract

We provide causal evidence of the deposits channel of monetary policy transmission in a new
setting, but show that bank entry can reduce or even reverse the relationship between deposit
market structure and monetary policy pass-through. We build a simple model of monetary policy
transmission when deposit market structure is endogenous. In our model, expansionary monetary
policy decreases bank funding costs and stimulates bank entry, which in turn stimulates
aggregate credit provision. Using novel shocks to bank entry barriers, we confirm the model’s
main predictions: the deposits channel exists, but local establishment and employment growth
increase more in response to expansionary monetary policy when bank entry barriers are lower.
Our results suggest that the deposits channel and the effects of expansionary monetary policy are
tamed when bank entry costs are high, as is currently the case.

JEL Classification: G12, G21, G28, E51, E52, E58