Distributive Effects of Banking Sector Losses

Abstract

This paper examines the impact of banking sector losses on inequality in a quantitative model with income and portfolio heterogeneity among households and financial intermediation frictions. Consistent with U.S. data, the model predicts that low-income households are disproportionately affected. Their consumption declines significantly due to higher borrowing costs and labor income losses. Highincome households are better insured through liquid assets. About 20% of them benefit from temporary asset price declines and higher future returns by adjusting their illiquid savings. These portfolio adjustments shape aggregate dynamics in the presence of financial frictions, by affecting the relative response of consumption and investment to aggregate shocks.

Keywords: Banking Crises, Financial Frictions, Household Heterogeneity, Portfolio Choice