Payment Risk and Bank Lending: Reassessing the Bundling of Payment Services and Credit Provision

Fisher College of Business Working Paper No. 2021-03-017

Charles A. Dice Center Working Paper No. 2021-17

78 Pages Posted: 8 Nov 2021 Last revised: 17 Oct 2023

See all articles by Ye Li

Ye Li

University of Washington - Foster School of Business

Yi Li

Board of Governors of the Federal Reserve System

Date Written: December 18, 2021

Abstract

Banks finance lending with deposits and support the operation of payment system by allowing depositors to freely transfer funds in and out of their deposit accounts. This bundling of financial services creates a liquidity mismatch. Using granular payment data, we characterize a sizeable liquidity risk exposure that banks face due to highly volatile payment flows. Payment risk is a form of funding stability risk that is unique to banks. Our analysis demonstrates the tension between the monetary role and financing role of deposits. We find that payment risk dampens bank lending: An interquartile increase in payment risk is associated with a decline in loan growth that is 10%-20% of its standard deviation. This detrimental effect is amplified by funding stress in broader financial markets and is stronger for undercapitalized banks. Furthermore, payment risk impedes the bank lending channel of monetary policy transmission. Finally, we characterize how banks mitigate payment risk by adjusting deposit rates.

Keywords: Credit supply, deposits, payment, funding stability, monetary policy transmission

JEL Classification: E42, E43, E44, E51, E52, G21, G28

Suggested Citation

Li, Ye and Li, Yi, Payment Risk and Bank Lending: Reassessing the Bundling of Payment Services and Credit Provision (December 18, 2021). Fisher College of Business Working Paper No. 2021-03-017, Charles A. Dice Center Working Paper No. 2021-17, Available at SSRN: https://ssrn.com/abstract=3959110 or http://dx.doi.org/10.2139/ssrn.3959110

Ye Li (Contact Author)

University of Washington - Foster School of Business ( email )

Box 353200
Seattle, WA 98195
United States

HOME PAGE: http://https://yeli-macrofinance.com/

Yi Li

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-721-4576 (Phone)

HOME PAGE: http://sites.google.com/view/yili/

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