Costly External Financing and Monetary Policy Transmission: Evidence from a Natural Experiment

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| Language:English

Abstract

I provide new evidence that large and small banks have different external financing costs, which generates cross sectional variation in a deposits market pricing power channel of monetary policy transmission. I do so by exploiting a natural experiment using anti-trust related bank branch divestitures. In these divestitures branches are transferred from large to small banks such that the branches are largely preserved and market structure remains unchanged. Consistent with the existence of capital market imperfections at small banks, I find that – holding market concentration constant – lending declines in areas local to branches newly owned by small banks, and deposit rates increase by more, when interest rates increase. My results are confirmed with geographically granular tests utilizing the entire sample of data, and indicate that financing frictions still matter for the transmission of monetary policy through banks.