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How do banks respond to increased funding uncertainty?

  • Ritz, R. A.
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    This paper presents a simple model of risk-averse banks that face uncertainty over funding conditions in the money market. It shows that increased funding uncertainty: (i) creates risk-based loan-deposit synergies, (ii) often causes banks' lending volumes and their profitability to decline, (iii) can explain more intense competition for retail deposits (including deposits turning into a "loss leader"), and (iv) typically dampens the rate of pass-through from changes in the central bank's policy rate to market interest rates. These results can explain some elements of commercial banks' behaviour and the reduced effectiveness of monetary policy during the 2007/9 financial crisis.

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    Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1213.

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    Date of creation: 07 Mar 2012
    Date of revision:
    Handle: RePEc:cam:camdae:1213
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    1. Michiel Van Leuvensteijn & Christoffer Kok Sorensen & Jacob A. Bikker & Adrian A.R.J.M. Van Rixtel, 2011. "Impact of bank competition on the interest rate pass-through in the euro area," Post-Print hal-00763955, HAL.
    2. Kit, Pong Wong, 1997. "On the determinants of bank interest margins under credit and interest rate risks," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 251-271, February.
    3. John B. Taylor & John C. Williams, 2008. "A black swan in the money market," Working Paper Series 2008-04, Federal Reserve Bank of San Francisco.
    4. Evan Gatev & Til Schuermann & Philip E. Strahan, 2006. "Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary with Market Conditions," NBER Working Papers 12234, National Bureau of Economic Research, Inc.
    5. Xavier Freixas & José Jorge, 2008. "The Role of Interbank Markets in Monetary Policy: A Model with Rationing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(6), pages 1151-1176, 09.
    6. Gara Afonso & Anna Kovner & Antoinette Schoar, 2010. "Stressed not Frozen: The Fed Funds Market in the Financial Crisis," NBER Working Papers 15806, National Bureau of Economic Research, Inc.
    7. Joseph P. Hughes & Loretta J. Mester, 1998. "Bank Capitalization And Cost: Evidence Of Scale Economies In Risk Management And Signaling," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 314-325, May.
    8. Xavier Freixas & Cornelia Holthausen, 2001. "Interbank market integration under asymmetric information," Economics Working Papers 579, Department of Economics and Business, Universitat Pompeu Fabra.
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    11. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
    12. Hannan, Timothy H & Berger, Allen N, 1991. "The Rigidity of Prices: Evidence from the Banking Industry," American Economic Review, American Economic Association, vol. 81(4), pages 938-45, September.
    13. repec:oup:qjecon:v:95:y:1980:i:2:p:309-31 is not listed on IDEAS
    14. John H. Boyd & Gianni De Nicolã, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, 06.
    15. Yasuo Nishiyama, 2007. "Are Banks Risk-Averse?," Eastern Economic Journal, Eastern Economic Association, vol. 33(4), pages 471-490, Fall.
    16. John O’Neill, 2009. "Market," Chapters, in: Handbook of Economics and Ethics, chapter 42 Edward Elgar.
    17. Angelini, Paolo, 2000. "Are Banks Risk Averse? Intraday Timing of Operations in the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(1), pages 54-73, February.
    18. Neven, Damien & Roller, Lars-Hendrik, 1999. "An aggregate structural model of competition in the European banking industry," International Journal of Industrial Organization, Elsevier, vol. 17(7), pages 1059-1074, October.
    19. Jeremy C. Stein, 1995. "An Adverse Selection Model of Bank Asset and Liability Management with Implications for the Transmission of Monetary Policy," NBER Working Papers 5217, National Bureau of Economic Research, Inc.
    20. Kim, Moshe & Kliger, Doron & Vale, Bent, 2003. "Estimating switching costs: the case of banking," Journal of Financial Intermediation, Elsevier, vol. 12(1), pages 25-56, January.
    21. Steven A. Sharpe, 1989. "Asymmetric information, bank lending, and implicit contracts: a stylized model of customer relationships," Finance and Economics Discussion Series 70, Board of Governors of the Federal Reserve System (U.S.).
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