Working Paper: NBER ID: w24582
Authors: Itamar Drechsler; Alexi Savov; Philipp Schnabl
Abstract: We show that maturity transformation does not expose banks to significant interest rate risk|it hedges it. This is due to banks' deposit franchise. The deposit franchise gives banks substantial market power over deposits, allowing them to pay deposit rates that are low and insensitive to market interest rates. Maintaining this power requires banks to incur large, interest-insensitive operating costs, so that the total costs of deposits are similar to fixed-rate, long-term debt. Hedging these costs therefore requires banks to lend long term|i.e., to do maturity transformation. As predicted by this theory, we document that banks' net interest margins have been highly stable and insensitive to interest rates, and banks' net worth is largely insulated from monetary policy shocks. We further show that banks match the interest-rate sensitivities of their expenses and income one-for-one, so that banks with less interest-sensitive deposits (more market power) hold assets with substantially longer duration. Our results show that deposits are special because they are short-term and yet have interest-insensitive costs, which explains why banks are able to supply long-term credit.
Keywords: Maturity Transformation; Interest Rate Risk; Deposit Franchise; Banking Theory
JEL Codes: E43; E52; G21; G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deposit franchise (G28) | low and insensitive deposit rates (E43) |
| low and insensitive deposit rates (E43) | stable net interest margins (E43) |
| stable net interest margins (E43) | lack of exposure to interest rate shocks (E43) |
| maturity transformation practices (G21) | reduced risk exposure (G52) |
| stronger deposit franchise (G21) | less sensitivity in interest expenses (G32) |
| less sensitivity in interest expenses (G32) | holding more long-term assets (G32) |
| matching of income and expense sensitivities (G59) | profitability unexposed to interest rate changes (G19) |
| interest-insensitive operating costs (D25) | resemble fixed-rate long-term debt (G32) |
| maturity mismatch (F32) | insulating profits from interest rate risk (G19) |