IDEAS home Printed from https://ideas.repec.org/p/fip/feddwp/97131.html
   My bibliography  Save this paper

Deposit Convexity, Monetary Policy and Financial Stability

Author

Listed:

Abstract

In principle, bank deposits can be withdrawn on demand. In practice, depositors tend to maintain stable balances for long periods, allowing banks to fund long-dated assets. Nevertheless, the cost of deposit funding influences banks’ capacity for maturity transformation. Banks and researchers conventionally model the response of deposit interest rates to market interest rates as constant, implying that deposits have nearly constant duration. Contrary to this standard assumption, we show empirically that the “beta” of deposit rates to market rates increases as market rates rise, causing the duration of deposits to fall. The amount of duration risk delivered to bank balance sheets via this channel from March 2022 to September 2023 is comparable in magnitude to the amount of duration risk absorbed by each of the several large-scale asset purchase programs the Federal Reserve has undertaken since 2008. Dynamic betas present a significant challenge to bank portfolio hedgers by introducing large and dynamic risks that are difficult to model and impractical to replicate on the asset side of the balance sheet. As a result, deposit convexity amplifies monetary policy transmission and increases financial fragility, mechanisms that recent banking stresses have highlighted.

Suggested Citation

  • Emily Greenwald & Sam Schulhofer-Wohl & Josh Younger, 2023. "Deposit Convexity, Monetary Policy and Financial Stability," Working Papers 2315, Federal Reserve Bank of Dallas.
    • Handle: RePEc:fip:feddwp:97131
    DOI: 10.24149/wp2315
    as

    Download full text from publisher

    File URL: https://www.dallasfed.org/-/media/documents/research/papers/2023/wp2315.pdf
    File Function: Full text
    Download Restriction: no
    File URL: https://libkey.io/10.24149/wp2315?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Itamar Drechsler & Alexi Savov & Philipp Schnabl, 2017. "The Deposits Channel of Monetary Policy," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(4), pages 1819-1876.
    2. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    3. Canlin Li & Min Wei, 2013. "Term Structure Modeling with Supply Factors and the Federal Reserve's Large-Scale Asset Purchase Progarms," International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 3-39, March.
    4. James D. Hamilton & Jing Cynthia Wu, 2012. "The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(s1), pages 3-46, February.
    5. Itamar Drechsler & Alexi Savov & Philipp Schnabl, 2021. "Banking on Deposits: Maturity Transformation without Interest Rate Risk," Journal of Finance, American Finance Association, vol. 76(3), pages 1091-1143, June.
    6. Deborah Leonard & Antoine Martin & Simon M. Potter & Brett Rose, 2017. "How the Fed Changes the Size of Its Balance Sheet: The Case of Mortgage-Backed Securities," Liberty Street Economics 20170711, Federal Reserve Bank of New York.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Carletti, Elena & De Marco, Filippo & Ioannidou, Vasso & Sette, Enrico, 2021. "Banks as patient lenders: Evidence from a tax reform," Journal of Financial Economics, Elsevier, vol. 141(1), pages 6-26.
    2. Berger, Allen N. & Boot, Arnoud W.A., 2024. "Financial intermediation services and competition analyses: Review and paths forward for improvement," Journal of Financial Intermediation, Elsevier, vol. 57(C).
    3. Jiang, Erica Xuewei & Matvos, Gregor & Piskorski, Tomasz & Seru, Amit, 2024. "Monetary tightening and U.S. bank fragility in 2023: Mark-to-market losses and uninsured depositor runs?," Journal of Financial Economics, Elsevier, vol. 159(C).
    4. Liu, Shiyu & Wang, Bo & Zhang, Qianqian, 2024. "Fintech regulation and bank liquidity creation: Evidence from China," Pacific-Basin Finance Journal, Elsevier, vol. 84(C).
    5. Claußen, Catharina & Platte, Daniel, 2023. "Evaluating the validity of regulatory interest rate risk measures – a simulation approach," Journal of Banking & Finance, Elsevier, vol. 154(C).
    6. Toni Ahner & Katrin Assenmacher & Peter Hoffmann & Agnese Leonello & Cyril Monnet & Davide Porcellacchia, 2024. "The Economics of Central Bank Digital Currency," International Journal of Central Banking, International Journal of Central Banking, vol. 20(4), pages 221-274, October.
    7. Dong Beom Choi & Paul Goldsmith-Pinkham & Tanju Yorulmazer, 2023. "Contagion Effects of the Silicon Valley Bank Run," NBER Working Papers 31772, National Bureau of Economic Research, Inc.
    8. Li, Lei & Loutskina, Elena & Strahan, Philip E., 2023. "Deposit market power, funding stability and long-term credit," Journal of Monetary Economics, Elsevier, vol. 138(C), pages 14-30.
    9. Nimrod Segev & Sigal Ribon & Michael Kahn & Jakob Haan, 2024. "Low Interest Rates and Banks’ Interest Margins: Does Deposit Market Concentration Matter?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 65(2), pages 189-218, June.
    10. Semyon Malamud & Andreas Schrimpf, 2016. "Intermediation Markups and Monetary Policy Passthrough," Swiss Finance Institute Research Paper Series 16-75, Swiss Finance Institute.
    11. Toni Ahnert & Kartik Anand & Philipp Johann König, 2024. "Real Interest Rates, Bank Borrowing, and Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 56(6), pages 1545-1571, September.
    12. Ramaprasad Bhar & Malliaris & Mary Malliaris, 2015. "The impact of large-scale asset purchases on the S&P 500 index, long-term interest rates and unemployment," Applied Economics, Taylor & Francis Journals, vol. 47(55), pages 6010-6018, November.
    13. Fascione, Luisa & Oosterhek, Koen & Scheubel, Beatrice & Stracca, Livio & Wildmann, Nadya, 2024. "Keep calm, but watch the outliers: deposit flows in recent crisis episodes and beyond," Occasional Paper Series 361, European Central Bank.
    14. Fudulache, Adina-Elena & Goetz, Martin R., 2023. "Long-term deposit funding and demand for central bank funds: Evidence from targeted longer-term refinancing operations," Discussion Papers 12/2023, Deutsche Bundesbank.
    15. Lutz, Chandler, 2015. "The impact of conventional and unconventional monetary policy on investor sentiment," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 89-105.
    16. Isabel Gödl-Hanisch, 2023. "Bank Concentration and Monetary Policy Pass-Through," CESifo Working Paper Series 10378, CESifo.
    17. Reiter, Michael & Zessner-Spitzenberg, Leopold, 2023. "Long-term bank lending and the transfer of aggregate risk," Journal of Economic Dynamics and Control, Elsevier, vol. 151(C).
    18. Mark Egan & Stefan Lewellen & Adi Sunderam, 2017. "The Cross Section of Bank Value," NBER Working Papers 23291, National Bureau of Economic Research, Inc.
    19. Neely, Christopher J., 2015. "Unconventional monetary policy had large international effects," Journal of Banking & Finance, Elsevier, vol. 52(C), pages 101-111.

    More about this item

    Keywords

    banks; Depository institutions; interest rates; bank run; financial markets; central bank; monetary policy; Policy Effects;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:feddwp:97131. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Amy Chapman (email available below). General contact details of provider: https://edirc.repec.org/data/frbdaus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.