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Bank lending and interest-on-excess-reserves: Effects of Central Banks on the global credit supply

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  • Erten, Irem

Abstract

How do banks behave when the opportunity cost of keeping overnight liquidity is less? In this paper, I study the adoption of unconventional monetary policy with interest-on-excess-reserves (IOER) in the pre-2008-crisis period in Australia, Canada, Europe, Japan, and the United Kingdom. Exploiting this cross-border shock to the monetary design, I show that global banks move liquidity to their home countries and reduce their cross-border credit supply when their home Central Bank introduces a deposit facility that remunerates overnight excess reserves. The credit supply reduction is focused on the smaller, less profitable, and more illiquid branches of the affected banks. Thus, a reduction in the opportunity cost of overnight liquidity has a contractionary impact on the credit supply and results in global macroeconomic spillovers. The results suggest that banks cut lending when the Central Bank is a risk-free borrower and have broad implications for the design of monetary policy, payment systems, and liquidity regulations.

Suggested Citation

  • Erten, Irem, 2025. "Bank lending and interest-on-excess-reserves: Effects of Central Banks on the global credit supply," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 103(C).
    • Handle: RePEc:eee:intfin:v:103:y:2025:i:c:s1042443125000757
    DOI: 10.1016/j.intfin.2025.102185
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    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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