Monetary Policy, Deposit Funding Shocks, and Bank Credit Supply: Bank-Level IV Evidence

This paper examines how monetary tightening transmits to bank credit supply through deposit funding conditions during the 2022-23 cycle. Using a quarterly panel of more than 3,800 US commercial banks, it constructs predetermined exposure indices measuring depositor sophistication, branch intensity, and local deposit-market concentration, and interacts these exposures with cumulative changes in the federal funds rate to form bank-level shift-share instruments. These interactions are employed in a two-stage least-squares framework to instrument for cumulative changes in effective deposit rates and, in parallel specifications, deposit quantities. The exposure indices explain substantial cross-bank heterogeneity in deposit-rate pass-through with signs consistent with canonical predictions, and jointly provide a strong instrument for cumulative change in effective deposit rates. By contrast, the corresponding results for deposit quantities are weaker and less intuitive. In the second stage, a larger policy-induced increase in a bank’s effective deposit rate is associated with a statistically and economically significant deceleration in the growth of loans not held for sale, consistent with a funding-cost channel through which tightening reduces credit supply. Quantity-based specifications that instrument for deposit growth, however, yield either weak identification or coefficients of the opposite sign, consistent with deposit volumes being endogenous to deposit pricing and with banks' capacity to substitute across liability classes as core deposits run off. Overall, the evidence supports a deposit channel that operates primarily through funding costs and depositor-composition–driven pricing behavior rather than through a mechanical balance-sheet constraint tied to deposit quantities.