How Monetary Policy Changes Bank Liability Structure and Funding Cost

Abstract

U.S. banks obtain most of their funding from a combination of zero-interest deposits and interest-bearing deposits. Using local demographic variations as instruments for banks' liability composition, I show that when monetary policy tightens, banks with a larger proportion of zero-interest deposits on their balance sheet experience larger increases in their interest-bearing deposit rate. This happens because tight monetary policy reduces the quantity of zero-interest deposits available to banks. Banks react issuing more interest-bearing deposits, but pay an interest rate that increases with the quantity being borrowed. This new evidence supports the existence of the bank lending channel of monetary policy.

Keywords: Banks, Deposits, Lending Channel, Monetary Policy

JEL Classification: E44, E50, G21, L16