Working Paper: NBER ID: w25196
Authors: Joo Granja; Christian Leuz; Raghuram Rajan
Abstract: The average distance of U.S. banks from their small corporate borrowers increased before the global financial crisis, especially for banks in competitive counties. Small distant loans are harder to make, so loan quality deteriorated. Surprisingly, such lending intensified as the Fed raised interest rates from 2004. Why? We show banks’ responses to higher rates led to bank deposits shifting into competitive counties. Short-horizon bank management recycled these inflows into risky loans to distant uncompetitive counties. Thus, rate hikes, competition, and managerial short-termism explain why inflows ‘burned a hole’ in banks’ pockets and, more generally, increased risky lending.
Keywords: bank lending; credit cycles; distance lending; financial crisis; risk-taking
JEL Codes: E32; E44; G01; G18; G21; G32; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lending distance increases (F34) | loan performance deteriorates (G33) |
| bank competition increases (G21) | lending distance increases (F34) |
| lending distance increases (F34) | charge-off rates increase (G32) |
| economic boom (E32) | lending distance increases (F34) |
| lending distance increases (F34) | interest rate sensitivity decreases (E43) |
| lower Tier 1 capital ratios (G32) | lending distance increases (F34) |
| lending distance increases (F34) | risk-taking behavior increases (D91) |
| economic downturn (F44) | lending distance decreases (G21) |