Deposit Competition and Financial Fragility: Evidence from the US Banking Sector

Abstract

We develop and estimate an empirical model of the U.S. banking sector using data covering the largest U.S. banks over the period 2002-2013. Our model incorporates insured depositors and run-prone uninsured depositors who choose between differentiated banks. Banks compete for deposits and can endogenously default. We estimate demand for uninsured deposits and find that it declines with banks' financial distress, which is not the case for insured deposits demand. We calibrate the supply side of the model and find that the deposit elasticity to bank default is large enough to introduce the possibility of multiple equilibria, suggesting that banks can be very fragile. Last, we use our model to analyze the proposed bank regulatory changes. For example, our results suggest that the capital requirement below 17% can lead to significant instability in the banking system, and that a requirement of 31% maximizes the welfare of the worst equilibrium.

Corporate Governance and Financial Distress in the Banking Industry: Nigerian Experience

“…Growth (growth) proxied by customer deposits presents a negative coefficient and statistically significant indirect effect on financial distress at a 5% significance level, implying that the propensity to withdraw deposits increases with the magnitude of financial distress. This finding is in line with the works of Goldstein and Pauzner (2005) and Egan, Hortacsu, and Matvos (2015) who affirm that distressed banks experience large decline in customer deposits.…”

Monetary Transmission through Shadow Banks

“…This means that a small shock to the underlying asset value may lead to large withdrawals by depositors. Large withdrawals may force shadow banks to liquidate assets at a fire-sale price, which may further depress the asset value, resulting in self-reinforcing runs (Egan et al 2017a). The risk of bank runs is further aggravated by the fact that shadow bank deposits are not insured.…”

“…Following this line of research, I introduce product differentiation and depositor heterogeneity into the existing framework of Drechsler et al (2017) and find that monetary tightening may have expansionary effects on certain types of banks depending on their transaction convenience and depositor clientele. This paper also adds to a new and growing body of literature that applies a structural IO approach to financial intermediation topics such as bank runs (Egan, Hortaçsu, and Matvos 2017a), bank value creation (Egan, Lewellen, and Sunderam 2017b), insurance (Koijen and Yogo 2016), and mortgages (Buchak, Matvos, Piskorski, and Seru 2017). This paper is the first attempt to use a structural IO model to study transmission channels of monetary policy.…”

“…I show that shadow banks face much more elastic demand than commercial banks as a result of product differentiation. With highly elastic demand, a small shock to the underlying asset value may trigger a large withdrawal of deposits, forcing shadow banks to liquidate assets at fire-sale prices and resulting in self-reinforcing bank runs (Egan et al 2017a). Therefore, the yield-sensitive clientele could be an additional source of financial fragility for the shadow banking sector.…”

Capital Requirements and Bailouts

“…The effect of increasing capital requirements on the stability of the financial system has been the subject of an intense academic and policy debate, particularly after the 2008 crisis. On the academic side, many studies argue that a substantial increase in capital requirements would improve the stability of the financial system (see, e.g., Admati et al, 2017 or Egan et al, 2017), while other studies focus on the potentially high costs of increasing capital requirements (see, e.g., Van den Heuvel, 2008). There are also quantitative structural studies, which develop fully fledged equilibrium models of an economy with a banking sector and can produce an evaluation of the full impact of higher capital requirements, in terms of both increased stability and higher costs.…”