Which Banks Smooth and at What Price?

2018. No. 01.

Vinogradov D., Kokas S., Zachariadis M.

By adjusting their lending, banks can smooth or amplify the macroeconomic impact of deposit fluctuations. This may however lead to extended periods of disproportionately high lending relative to deposit intake, resulting in the accumulation of risk in the banking system. Using bank-level data for 8,477 banks in 129 countries for the 24-year period from 1992 to 2015, we examine how individual banks' market power and other characteristics may contribute to smoothing or amplification of shocks and to 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 would be associated with a greater fall in lending resulting in amplification of adverse effects as deposits fall 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 contribute to smoothing of adverse effects when deposits are falling. In periods of rising deposits, however, such banks lead to amplification and accumulation of risk in the economy.

Keywords: competition, market power, crisis, smoothing, amplification, risk accumulation