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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
The bank lending channel of monetary policy and its effect on mortgage lending
Lamont K. Black
Diana Hancock
Wayne Passmore
Abstract

The bank lending channel of monetary policy suggests that banks play a special role in the transmission of monetary policy. We look for this special role by examining the business strategies of banks as it relates to mortgage funding and mortgage lending. "Traditional banks" have a large supply of excess core deposits and specialize in information-intensive lending to borrowers (which is proxied here using mortgage lending in subprime communities), whereas "market-based banks" are funded with managed liabilities and mainly lend to relatively easy-to-evaluate borrowers. We predict that only "transition banks" operating between these business strategies are likely to increase their loan rate spreads substantially in response to monetary tightening. To fund ongoing mortgage originations, these banks must substitute from core deposits to managed liabilities, which have a large external finance premium due to these banks' information-intensive lending. Consistent with this prediction, we find evidence of a bank lending channel only among transition banks - they significantly reduce mortgage lending in response to monetary contractions.


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Lamont K. Black & Diana Hancock & Wayne Passmore, The bank lending channel of monetary policy and its effect on mortgage lending, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2010-39, 2010.
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Keywords: Mortgage loans ; Subprime mortgage
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