Working Papers

2017-03 | November 2017

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De-leveraging or de-risking? How banks cope with loss

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Using detailed bank balance sheet data we examine how banks respond to a net worth shock. We make use of variation in banks' loan exposure to industries adversely affected by the oil price declines of 2014 and the implied variation in losses resulting from credit deterioration in those industries. In response to these losses, exposed banks reduced the risk of their balance sheets by shifting away from portfolio lending and towards assets with lower risk weights. Banks tightened credit on corporate lending and on mortgages that they would ultimately hold in their portfolio. However, they expanded credit for mortgages to be securitized. Our results imply that previous work suggesting that banks tighten credit in response to a shock provides only a partial story and is in some ways misleading. It appears that banks respond to a negative shock by de-risking rather than a uniform reduction in lending. In terms of the ultimate impact on borrowers, we find that the shock had only a minimal impact on the overall quantity of loans supplied to firms or households, reflecting substitution to other sources of financing.

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Article Citation

Bidder, Rhys M, John R. Krainer, and Adam H. Shapiro. 2017. "De-leveraging or de-risking? How banks cope with loss," Federal Reserve Bank of San Francisco Working Paper 2017-03. Available at https://doi.org/10.24148/wp2017-03