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How do banks respond to increased funding uncertainty?

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  • Ritz, R. A.

Abstract

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.

Suggested Citation

  • Ritz, R. A., 2012. "How do banks respond to increased funding uncertainty?," Cambridge Working Papers in Economics 1213, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:1213
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    More about this item

    Keywords

    Bank lending; interbank market; interest rate pass-through; loan-to-deposit ratio; loan-deposit synergies; loss leader; monetary policy;
    All these keywords.

    JEL classification:

    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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