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  3. 2024
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  5. Financial Intermediation: Bank Lending
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Financial Intermediation: Bank Lending

Paper Session

Sunday, Jan. 7, 2024 1:00 PM - 3:00 PM (CST)

Marriott Rivercenter, Grand Ballroom Salon G
Hosted By: American Finance Association
  • Chair: Shan Ge, New York University

The Secular Decline in Interest Rates and the Rise of Shadow Banks

Andres Sarto
,
New York University
Olivier Wang
,
New York University

Abstract

Over the past two decades, shadow banks have significantly expanded their share of residential mortgage lending, even surpassing pre-financial crisis levels. This surge is often attributed to post-crisis regulatory changes and improvements in shadow banks’ technology. In this paper, we document a new driving force: the persistent decline in interest rates. When interest rates are high, cheap deposit funding provides banks with a significant competitive advantage against shadow banks relying on wholesale funding. As interest rates plummet, banks lose this advantage, experience a squeeze in their net interest margin, leading to diminished profitability, weaker growth, and cost-cutting measures such as branch closures. By contrast, shadow banks are able to gain market share. We test this mechanism using a shift-share empirical design based on differences in historical bank balance sheet composition. We find that banks more vulnerable to falling interest rates contracted lending as a response to lower profitability while also scaling back non-interest expenses on their branches. This created a fertile environment for non-banks to expand in areas with banks exposed to declining interest rates.

The Financial Transmission of a Climate Shock: El Nino and US Banks

Filippo De Marco
,
Bocconi University
Nicola Limodio
,
Bocconi University

Abstract

This paper investigates how a climate shock affects the banking system. We leverage El Nino, a recurring natural phenomenon inducing quasi-random variation in temperatures across the US. El Nino leads to lower house prices and mortgage lending in counties experiencing temperature increases. Higher temperatures increase water and soil salinity, which negatively affects both crop yields and local natural amenities. Banks exposed to El Nino reduce their mortgage lending even in counties unaffected by temperature increases. Using a LASSO analysis we find that banks with lower operating leverage (i.e., lower expenses on physical premises) are more climate-resilient.

Trade Shocks Through Banking Lending Channel

Hengguo Da
,
Southwestern University of Finance and Economics

Abstract

In this paper, we trace a fully-specified bank lending channel by using a trade shock, the law of the US granting China Permanent Normal Trade Relation Status (PNTR shock) in 2001. PNTR shock enables us to delineate a clear pathway of the shock’s transmission. Specifically, PNTR shock causes banks to terminate their lending relationship and tighten loan contracts with firms in the trade sector. Next, PNTR shock negatively impacts the bank’s performance via lending relationships. In response to the PNTR shock, banks hedge risk by holding more security assets. Finally, Banks pass this shock to non-trade sector firms in their loan portfolio. Using a micro econometrics estimate, we infer that the PNTR shock leads to a 38.44 percent loan loss in the macroeconomy. Therefore, our empirical results highlight a bank’s special role as an inter-industry shock transmitter and have policy implications for the bank industry in the United States.

Discussant(s)
Erica Xuewei Jiang
,
University of Southern California
Abhishek Bhardwaj
,
Tulane University
Shan Ge
,
New York University
JEL Classifications
  • G2 - Financial Institutions and Services