Essays on Banking

Abstract

I explore the determinants of banks' deposit funding conditions and their implications for banks' lending decisions. In the first chapter, I uncover a new distortionary mechanism through which unemployment insurance policies affect bank deposits. Large number of countries provide unemployment insurance (UI) to reduce individuals' income risk and to moderate fluctuations in the economy. However, to the extent that these policies are successful, they would be expected to reduce precautionary savings and hence bank deposits –households' main saving instrument. I study this reduced incentive to save and uncover a novel distortionary mechanism through which UI policies affect the economy. In particular, I show that, when UI benefits become more generous, bank deposits fall. Since deposits are the main source of funding for banks, this fall in deposits squeezes bank commercial lending, which in turn reduces corporate investment.In the second chapter, I document a new mechanism through which banks gain flexibility to manage the size of their loan portfolio across monetary policy cycles. It is well-documented that an increase in the Fed funds rate reduces the lending capacity of banks, which in turn induces banks to cut corporate lending. However, it is not clear how banks achieve this reduction towards their existing borrowers because outstanding long-term loans may limit their ability to do so. I study how banks set loan contract terms to prepare for future contractionary monetary policy shocks. I find that banks with higher monetary policy exposure –banks whose lending capacity shrinks more during Fed hiking cycles– write loan contracts with stricter covenants. This ex-ante bank behavior makes borrowers more likely to violate covenants, giving banks the right to reduce lending ex-post when their lending capacity is hit by a monetary policy shock. These findings highlight the role of covenants in the transmission of monetary policy and imply that even firms with long-term loans remain exposed to monetary policy shocks.