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Money and Credit

Paper Session

Friday, Jan. 3, 2025 8:00 AM - 10:00 AM (PST)

Hilton San Francisco Union Square, Franciscan D
Hosted By: American Economic Association
  • Chair: Jens Christensen, Federal Reserve Bank of San Francisco

Efficient Capital Allocation in Banks: An Analysis Using Randomized Loan Pricing Experiments

Deniz Aydin
,
Washington University-St. Louis
Ernest Liu
,
Princeton University
Janis Skrastins
,
Washington University-St. Louis

Abstract

A fundamental question in finance is whether banks allocate capital in a way that equalizes marginal returns across divisions. Yet, there are many impediments to achieve efficient capital allocation (e.g., uniform pricing, redlining regulations). However, measuring these distortions and their impact on efficiency remains a difficult task. In this paper, we present new data and methods to evaluate inefficiencies in the allocation of capital in banks. First, we use naturally occurring variation and document large and persistent dispersions in the return to capital across organizational divisions. Second, we develop new methods to test for efficiency and quantify the resulting profit losses. The methods identify each division's marginal product of capital as a function of experimentally identified treatment effects, placing minimal restrictions on the extent of optimizing behavior or the underlying sources of the inefficiencies. We apply these techniques to study the allocative efficiency of a large bank’s internal capital markets through a field experiment that supplies capital at random prices. We statistically reject allocative efficiency, showing that deviations from efficiency are measurable, and estimate the profit losses by linking wedge dispersion through a second-order approximation. We find a profit loss of around 20%. We pinpoint uniform pricing and regulatory policies aimed at preventing redlining as two key frictions that hinder efficient capital allocation. We conclude by discussing implications.

Monetary Policy Shocks and Firms’ Bank Loan Expectations

Caterina Forti Grazzini
,
European Central Bank
Annalisa Ferrando
,
European Central Bank

Abstract

We evaluate the impact of the ECB’s monetary policy (MP) between 2009 and 2022 on euro area enterprises’ bank loan expectations using data from the Survey on the Access to Finance of Enterprises, a bi-annual euro area firm-level survey. We identify MP comparing expectations of those firms that respond to the survey shortly before and after the selected MP shocks. First, we find that contractionary MP shocks decrease bank loan expectations. Second, we document that only large and contractionary shocks have a significant impact on expectations, suggesting that the attention that firms pay to MP is endogenous to the size and the sign of the shocks. Third, we find that the information content and nature of shocks matter. We partition the MP shocks into pure MP shocks and the central bank information shocks –the latter capturing the possible impact on expectations of news of the current state of the economy revealed by the ECB during its MP announcements. Both shocks have the expected sign —a positive (contractionary) pure MP shock decreases expectations, while a positive central bank information shock increases them– but the effect of the latter is weak, suggesting that MP impacts firms’ bank loan expectations through its expected impact on bank loan conditions. By contrast, it might be not trivial for firms to understand how the current state of the economy revealed by an ECB announcement might impact bank loan conditions and update expectations accordingly. Nonetheless, this last finding does not apply to QE. While conventional contractionary MP shocks have a negative and significant impact on bank loan availability beliefs, QE contractionary shocks deliver a counter-intuitive positive impact on expectations, driven by the information content of these announcements. Finally, we show that the response to MP depends on firms’ characteristics

Money Markets, Collateral and Monetary Policy

Ciaran Rogers
,
HEC Paris
Fiorella De Fiore
,
Bank for International Settlements
Marie Hoerova
,
European Central Bank
Harald Uhlig
,
University of Chicago

Abstract

During the financial and sovereign debt crises, euro area interbank money markets underwent dramatic changes: the share of unsecured borrowing declined throughout the euro area, while private market haircuts on sovereign bonds and bank borrowing from the European Central Bank increased in the South. We construct a quantitative general equilibrium model to evaluate the macroeconomic impact of these developments and the associated policy response. Our model features heterogeneous banks and sovereign bonds, secured and unsecured money markets, and a central bank. We compare a benchmark policy – the central bank providing collateralized lending to banks at haircuts lower than the market - to an alternative policy that maintains a constant central bank balance sheet. We show that the fall in output, investment, and capital would have been twice as high under the alternative policy. More generally, the model allows the analysis of monetary policy tools beyond interest rate policies and quantitative easing

Savings-and-Credit Contracts

Armando Gomes
,
Washington University-St. Louis
Janis Skrastins
,
Washington University-St. Louis
David Schoenherr
,
Princeton University
Bernardus van Doornik
,
Central Bank of Brazil

Abstract

In this paper, we introduce a Savings-and-Credit Contract (SCC) that mandates a
savings period with a default penalty before providing credit. This design mitigates
adverse selection. We show that SCCs can dominate classic loan contracts amidst
information frictions, thereby expanding access to credit. Empirical evidence from a
financial product that features an SCC design supports the theory. While appearing
riskier on observables, product participants have lower realized default rates than bank
borrowers. Further consistent with the theory, a reform that reduces the default penalty
during the savings period leads to worse selection and higher realized default rates
among product participants.

“If You Don't Know Me by Now ...” Banks’ Private Information and Relationship Length

Teng Wang
,
Federal Reserve Board
Steven Ongena
,
University of Zurich
Stijn Claessens
,
Bank for International Settlements

Abstract

Does private information banks generate about their corporate borrowers deepen and change in nature over time, and if so, how? Exploiting the comprehensive Federal Reserve’s supervisory dataset, we distinguish two private information dimensions embedded in internal credit ratings: depth and direction (better or worse). After showing that depth and direction are associated with loan terms, we document that longer firmbank relationships deepen private information often strongly nonlinear, in both directions, and peaking at about five years. Learning effects are particularly salient for smaller and leveraged firms, smaller, leveraged, and illiquid banks, at longer firm-bank distances, and during non-COVID times.
JEL Classifications
  • G2 - Financial Institutions and Services