Tracing Banks’ Credit Allocation to Their Profits

We quantify how banks' funding-related expenses affect their lending behavior. For identification, we exploit banks' heterogeneous liability composition 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 average funding costs reduces banks' credit supply by 17%. To insulate their profits, affected banks also reach for yield and rebalance their lending towards smaller and riskier firms. These changes are not compensated for by less affected banks at the aggregate city level, which implies that large firms have to reduce their investment.