Bank Size, Bank Capital, and the Bank Lending Channel

TLDR

Banks are central to monetary policy transmission through the credit channel, which comprises the borrower net worth channel and the bank lending channel, and prior research has examined these subchannels. The study seeks to provide evidence for the credit channel in general and the bank lending channel in particular. The authors test for bank loan‑supply shifts by segregating banks according to asset size and capital‑leverage ratio. Evidence shows a credit channel and a bank lending channel in the United States from 1980 to 1995, with loan growth of small undercapitalized banks significantly affected by policy, highlighting the channel’s strength, distributional effects, and links to stabilization and regulatory policy.

Abstract

This paper provides evidence of a credit channel and a bank lending channel of monetary policy in the United States from 1980 to 1995. We test for bank loan supply shifts by segregating banks according to asset size and capital leverage ratio. The loan growth of small (under $300M) undercapitalized (capital-asset ratio 10%) banks is significantly affected by policy. This has important implications for the strength and distributional effects of monetary policy, and for the link between stabilization and regulatory policy. ACCURATELY DEFINING THE ROLE OF BANKS in the transmission of monetary policy may hold the key to explaining the effects of policy on the economy. In the credit channel, banks play a pivotal role in the transmission of policy. Assuming asymmetric information between lenders and borrowers, the credit channel offers an appealing explanation for the strength, timing, and distributional effects of policy on the economy. There are two subchannels within the credit channel that account for the role of banks in transmitting central bank impulses the borrower net worth channel (BNWC) (also known as the balance-sheet channel), and the bank lending channel (BLC). A body of literature over the last decade has tested for the existence of the credit channel and the two subchannels. In this paper we provide evidence in support of the credit channel, in general, and the bank lending channel, in particular.