Why is the Banking Sector Shrinking?

Paper ID: 96-18

Posted: 8 Oct 1996

See all articles by Mitchell Berlin

Mitchell Berlin

Federal Reserve Bank of Philadelphia - Research Department

Loretta J. Mester

Federal Reserve Banks - Federal Reserve Bank of Cleveland; University of Pennsylvania - The Wharton School

Date Written: August 1996

Abstract

We empirically examine the hypothesis that access to core deposits permits a bank to make contractual agreements with borrowers, which are infeasible if the bank must pay market rates for its funds. Access to core deposits insulates a bank's costs of funds from exogenous shocks. In turn, the bank can insulate its borrowers against exogenous credit shocks. Using a large sample of loans from the Survey of the Terms of Bank Lending, we find that when we control for competitive conditions in loan markets: (i) banks funded more heavily with core deposits provide more smoothing of loan rates in response to exogenous changes in aggregate credit risk; and (ii) banks funded more heavily with core deposits charge higher loan rates on average. Together these results suggest that a distinctive feature of bank lending is that firms and banks form multiperiod lending relationships, in which loans need not break even period by period. These results also provide a partial explanation for disintermediation. As banks have increasingly been forced to pay market rates for an increasing share of their funds, multiperiod relationship lending has become increasingly less feasible. The views expressed in this paper do not necessarily represent those of the Federal Reserve Bank of Philadelphia or of the Federal Reserve System.

JEL Classification: G2, G3, G1

Suggested Citation

Berlin, Mitchell and Mester, Loretta J., Why is the Banking Sector Shrinking? (August 1996 ). Paper ID: 96-18. Available at SSRN: https://ssrn.com/abstract=7795

Mitchell Berlin

Federal Reserve Bank of Philadelphia - Research Department ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
215-574-3822 (Phone)
215-574-4364 (Fax)

Loretta J. Mester (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

University of Pennsylvania - The Wharton School

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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