Why is the Banking Sector Shrinking?
Paper ID: 96-18
Posted: 8 Oct 1996
Date Written: August 1996
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: Suggested Citation