Deposit channel compels banks to optimize risk-return trade-off
A Banco de España working paper shows that the deposit channel of monetary policy compels banks to optimize their risk-return trade-off. Banks in concentrated deposit markets reduce credit to riskier firms, prioritizing prudence during tightening cycles.
Concentrated markets, prudent lending
The study examines the deposit channel during the euro area's fastest and most intense tightening cycle, leveraging regional variation in deposit market concentration.
Researchers used the Banco de España's Central Credit Register (CIRBE) and branch-level data from Spain's 2022–2024 tightening cycle.
They confirm the deposit channel's existence: branches in highly concentrated markets experienced significantly lower deposit growth compared to competitive markets.
This deposit-side funding shock translated into a contraction in lending supply, particularly for risky borrowers.
Banks exposed to concentrated deposit markets lowered lending supply by 10.5% relative to less-exposed banks, with an additional 4.6% cut for borrowers with high ex-ante probability of default.
This supports the franchise value hypothesis, where banks limit risk exposure to preserve their deposit franchise.
Higher rates, improved returns
Beyond lending volume and risk, the paper analyzes pricing and realized returns.
Exposed banks raised loan rates on new term loans by 20 basis points more than their peers.
Crucially, this increase in pricing was not accompanied by a deterioration in credit quality, leading directly to higher realized returns.
This highlights a novel dimension of the deposit channel: it compels banks to actively optimize their risk-return trade-off by rejecting risky borrowers while increasing margins on safe lending.
From a policy perspective, the findings show that the deposit channel amplifies the risk-taking channel, restraining risky lending through the franchise-value mechanism.
However, this enhanced resilience comes at the cost of lower credit supply for borrowers with weaker credit profiles.
Prudence over yield
This research offers a critical re-evaluation of monetary policy transmission, particularly in an era of rising rates.
It demonstrates how market structure fundamentally alters banks' risk appetite, reversing the 'search-for-yield' dynamic observed during the zero-lower-bound era.
For policymakers, this implies a complex trade-off between financial stability gains and potential constraints on credit access for certain segments of the economy.