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Banks and Central Banks

Paper Session

Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM

Sheraton Grand Chicago, Sheraton Ballroom II
Hosted By: American Finance Association
  • Chair: Arvind Krishnamurthy, Stanford University

The Effect of Monetary Policy on Bank Wholesale Funding

Dong Beom Choi
,
Federal Reserve Bank of New York
Hyun-Soo Choi
,
Singapore Management University

Abstract

We study how monetary policy affects the funding composition of the banking sector. When monetary tightening reduces the retail deposit supply due to, for example, a decrease in bank reserves or in money demand, banks try to substitute the deposit outflows with more wholesale funding in order to mitigate the policy impact on their lending. Banks have varying degrees of accessibility to wholesale funding sources because of financial frictions, and those banks that are large or that have a greater reliance on wholesale funding increase their wholesale funding more. As a result, monetary tightening increases both the reliance on and the concentration of wholesale funding within the banking sector, indicating that monetary tightening could increase systemic risk. For identification, we exploit regional age-demographics of bank customer-base as a measure of retail deposit supply elasticity to interest rate changes, and compare the effect on large and small banks within the age-demographic groups. Our findings also suggest that introducing liquidity requirements can bolster monetary policy transmission through the bank lending channel by limiting the funding substitution of large banks.

The Effect of Central Bank Liquidity Injections on Bank Credit Supply

Luisa Carpinelli
,
Bank of Italy
Matteo Crosignani
,
Federal Reserve Board

Abstract

We study the effectiveness of central bank liquidity injections in restoring bank credit supply following a wholesale funding dry-up. We combine the Italian credit registry with bank security-level holdings and analyze the transmission of the European Central Bank 3-year Long Term Refinancing Operation. Exploiting a regulatory change that expands the pool of eligible collateral, we show that banks more affected by the dry-up use the central bank liquidity to restore credit supply, while less affected banks to increase their holdings of high-yield government bonds. Unable to completely switch from affected banks during the dry-up, firms benefit from the intervention.

Lender of Last Resort Versus Buyer of Last Resort: Evidence From the European Sovereign Debt Crisis

Viral Acharya
,
New York University, CEPR, and NBER
Diane Pierret
,
University of Lausanne
Sascha Steffen
,
University of Mannheim

Abstract

In summer 2011, elevated sovereign risk in Eurozone peripheral countries increased the solvency risk of Eurozone banks, precipitating a run on their short-term debt. We assess the effectiveness of different European Central Bank (ECB) interventions that followed -- lender of last resort vs. buyer of last resort -- in stabilizing the European financial sector. We find that (i) by being lender of last resort to banks via the long-term refinancing operations (LTRO), ECB temporarily reduced funding pressure for banks, but did not help to contain sovereign risk. In fact, banks of the peripheral countries used the public funds to increase their exposure to risky domestic debt, so that when solvency risk in the Eurozone worsened the run of private short-term investors from Eurozone banks intensified. (ii) In contrast, ECB's announcement of being a potential buyer of last resort via the Outright Monetary Transaction program (OMT) significantly reduced the bank-sovereign nexus. The OMT increased the market prices of sovereign bonds, leading to a permanent reversal of private funding flows to Eurozone banks holding these bonds.

Monetary Policy and Global Banking

Falk Brauning
,
Federal Reserve Bank of Boston
Victoria Ivashina
,
Harvard Business School

Abstract

Global banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often not denominated in the same currency. This leads to an FX exposure that banks need to hedge. If cross-currency flows are large, the hedging cost increases diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity.
Discussant(s)
Alexi Savov
,
New York University
Marco Di Maggio
,
Harvard University and NBER
Jennie Bai
,
Georgetown University
Nicola Cetorelli
,
Federal Reserve Bank of New York
JEL Classifications
  • G2 - Financial Institutions and Services