The Federal Reserve’s Unconventional Policies and Bank Balance Sheets

Abstract

In this thesis, we investigate how unconventional monetary policy affects banking and its transmission through bank lending using the data from US market. The thesis is comprised of three main studies as follows.
The first study suggests that forward guidance, via publicly committing the central bank to future actions and creating associated expectations, fundamentally affects bank-lending decisions independently of other forms of monetary policy. To test this hypothesis, we build a forward guidance measure based on the language used in the Federal Open Market Committee meetings and match this measure with syndicated loans. Our results show that expansionary forward guidance decreases corporate loan spreads and that this effect is stronger for well-capitalized banks lending to riskier firms. The results support a risk-taking channel of unconventional monetary policy.
The second study examines the effect of Odyssean forward guidance on the establishment of new borrower-lender relationship and syndication structure. Using a narrative forward guidance measure based on the FOMC statements, we find that Odyssean forward guidance, by alleviating information asymmetry, encourages bank lending to riskier borrowers and increases the participation in syndicated loans manifested in a less concentrated syndication structure. The results are consistent with the argument that forward guidance alters the risk perception of banks and can stimulate the economy through the bank lending channel.
Finally, utilising banks’ heterogeneous exposure to large-scale asset purchases, the third study investigates how quantitative easing affects bank deposit funding. We find that the first and third rounds of quantitative easing significantly increase the deposit spreads and reduce the deposit amount through a liquidity effect. This indicates a shift of banks’ supply curve of deposit, which is a safe and liquid asset to households. The less dependence on deposit funding of banks suggests the role of bank market power in deposits channel is weakened during monetary policy easing and the role of liquidity becomes more important. QE2 has no effect on deposit spreads, consistent with its focus on Treasury securities that is trivial in bank balance sheets, but it affects the deposit amount from the demand side.
This thesis contributes to the ongoing discussion of the transmission channel of unconventional monetary policy. The findings have important policy implications since the use of these unconventional monetary policy tools will be a new normal.