Tracing Banks' Credit Allocation to their Funding Costs

We quantify how banks’ funding costs affect their lending behavior directly, and in-directly by feeding back to their net worth. For identification, we exploit banks’ het-erogeneous liability structure and the existence of regulated deposits in France whose rates are set by the government. Using administrative credit-registry and regulatory bank data, we find that a one-percentage-point increase in funding costs reduces credit by 17%. To insulate their profits, banks reach for yield and rebalance their lending towards smaller and riskier firms. These changes are not compensated for by less af-fected banks at the aggregate city level, with repercussions for firms’ investment.