Which banks smooth and at what price?

Abstract

By adjusting lending, banks can smooth the macroeconomic impact of deposit fluctuations. This may, however, lead to extended periods of disproportionately high lending relative to deposit intake and, under certain conditions, to the accumulation of risk in the banking system. Using bank-level data for 8477 banks in 129 countries for the period from 1992 to 2015, we examine how banks' market power and other characteristics may contribute to smoothing or amplification of shocks and the accumulation of risk. We find that the higher their market power the lower is the growth rate of lending relative to deposits. As a result, in periods of falling deposits higher market power for the average bank is associated with a greater fall in lending, consistent with amplification of adverse effects during relatively bad times. Strikingly, at very high levels of market power, there is a threshold past which the effect of market power on the growth rate of lending relative to deposits turns positive so that “superpower” banks may contribute to the smoothing of adverse effects when deposits are falling. In periods of rising deposits, however, such banks are more likely to lead to amplification and accumulation of risk in the economy.