The Bank Lending Channel of Monetary Policy and its Effect on Mortgage Lending

Lamont K. Black, Diana Hancock, S. Wayne Passmore
2010 Social Science Research Network  
The bank lending channel of monetary policy suggests that banks play a special role in the transmission of monetary policy. We look for this special role by examining the business strategies of banks as it relates to mortgage funding and mortgage lending. "Traditional banks" have a large supply of excess core deposits and specialize in information-intensive lending to borrowers (which is proxied here using mortgage lending in subprime communities), whereas "market-based banks" are funded with
more » ... naged liabilities and mainly lend to relatively easy-to-evaluate borrowers. We predict that only "transition banks" operating between these business strategies are likely to increase their loan rate spreads substantially in response to monetary tightening. To fund ongoing mortgage originations, these banks must substitute from core deposits to managed liabilities, which have a large external finance premium due to these banks' information-intensive lending. Consistent with this prediction, we find evidence of a bank lending channel only among transition banks -they significantly reduce mortgage lending in response to monetary contractions. * The views expressed are those of the authors and do not necessarily reflect those of the Board of Governors of the Federal Reserve System or its staff. The authors would like to thank Robert Avery and Skander van den Heuvel for helpful comments as well as Lieu Hazelwood, Akeel Rangwala, Christopher Reynolds, Sarah Reynolds and Sean Wallace for their outstanding research assistance. All errors remain those of the authors.
doi:10.2139/ssrn.1895500 fatcat:vy6zxwqpfrcpvayznlr4walonm