Bank loan portfolios and the monetary transmission mechanism

This 2007 Journal of Monetary Economics paper by Wouter den Haan, Steven Sumner, and Guy Yamashiro asks whether the three main categories of U.S. bank loans – commercial and industrial (C&I), real estate, and consumer – respond uniformly to monetary policy tightening, and uses the answer to adjudicate between a bank-lending-channel view (in which loan supply should contract across the board) and an alternative portfolio-substitution story. Using quarterly Call Report data on bank balance sheets from 1977:Q1 to 2004:Q2, the authors estimate a block-recursive (Cholesky) structural VAR in the style of Christiano, Eichenbaum, and Evans (1999), identifying a monetary policy shock as an innovation to the federal funds rate that is ordered so the Fed does not respond contemporaneously to the other system variables (a second identification, in which the Fed does respond contemporaneously to everything, delivers qualitatively the same results). Following a one-standard-deviation positive innovation to the federal funds rate – which rises by roughly 80 basis points on impact – C&I loans display a substantial and frequently significant increase, while real estate and consumer loans decline significantly, a pattern that runs directly counter to the standard bank-lending-channel prediction that all loan categories should contract when reserves tighten. To isolate whether this is simply a real-activity effect rather than a monetary one, the authors construct a “non-monetary downturn” – a sequence of real-income shocks calibrated to reproduce the same path of real income as the monetary tightening – and find the loan pattern flips: C&I loans fall sharply and immediately while real estate and consumer loans are little affected. The paper also shows this portfolio substitution is not explained by an inventory-financing story (adding inventories to the VAR and matching the inventory path as well as the income path still fails to generate a C&I increase), that bank book equity falls significantly during monetary tightening but not during the matched non-monetary downturn, and that C&I loan rates track the funds rate closely while consumer loan rates are sticky and long-term mortgage/Treasury rates overshoot what the expectations hypothesis predicts. The authors propose four non-exclusive explanations for why tightening pushes banks toward C&I and away from real estate/consumer lending: a stronger balance-sheet channel on the consumer side, stickiness of consumer loan rates, hedging of interest-rate risk via maturity-adjusting portfolio shifts, and Basel-Accord capital requirements that force banks whose book equity has fallen to shed higher risk-weight, long-term assets (real estate) in favor of lower risk-weight, short-term ones (C&I). Results are reported as robust to an alternative identification, a BIC-selected lag length, monthly H8 data over 1960-2003, and Romer-Romer (2004) narrative monetary shocks; the authors are explicit that this is an empirical exercise and that building a single structural model consistent with all the documented patterns is left as “an important challenge for future research.”

Wouter J. Den Haan | Macro Paper Warehouse

Bank loan portfolios and the monetary transmission mechanism