Deposit channel compels banks to optimize risk-return

The study validates the existence of the deposit channel in Spain, showing that branches in highly concentrated markets experienced significantly lower deposit growth.

This deposit-side funding shock led to a 10.5 percent reduction in lending supply for banks exposed to concentrated deposit markets, with an additional 4.6 percent cut for borrowers with a high ex-ante probability of default.

For newly originated loans, this contraction was accompanied by 20 basis points higher interest rates and improved realized returns, without a deterioration in credit quality.

This demonstrates that banks actively optimize their risk-return trade-off, prioritizing prudence and enhancing overall portfolio profitability.

The research contextualizes its findings within the European Central Bank's historically rapid tightening cycle, which began in July 2022 and ended a decade of ultra-low interest rates.

A key feature of this period was the disconnect between soaring policy rates and stagnant retail deposit rates, particularly in concentrated markets.

This limited pass-through allowed banks to widen intermediation margins, effectively increasing the value of their deposit franchise.

According to the franchise value hypothesis, preserving these rents makes downside risk more costly, thereby increasing banks' risk aversion and compelling them to de-risk their portfolios.