Research

Working Papers:

Monetary Policy and the Mortgage Market (with I. Drechsler, A. Savov, P. Schnabl),

Mortgage markets are central to monetary policy transmission. We show that this is because monetary policy impacts the supply of mortgage credit by the two largest mortgage holders: banks and the Federal Reserve. The Fed's supply of mortgage credit consists of buying or selling mortgage-backed securities (MBS) under its quantitative easing and tightening (QE and QT) programs. Banks' supply of mortgage credit is driven by the deposits channel of monetary policy. Under the deposits channel, when the Fed lowers rates, banks receive large inflows of deposits. They invest these deposits in long-term fixed-rate assets, in particular MBS, to match the interest-rate sensitivity of their income and expenses. The deposits channel reverses when the Fed raises rates: deposits flow out and banks sell MBS. Through the combined effect of QE/QT and the deposits channel, monetary policy drives mortgage rates, mortgage originations, and residential investment. We show that QE/QT and the deposits channel played a large role in the expansion and contraction of mortgage credit during the 2020--24 monetary policy cycle. Our results imply that monetary policy will continue to operate through these channels in future cycles.


Twin Defaults and Bank Capital Requirements (with C. Mendicino, K.Nikolov, J. Rubio Ramirez, J.Suarez),  

We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to non-diversifiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside but significant downside risk of loan portfolio returns (Nagel and Purnanandam, 2020). This helps to reproduce the frequency and severity of twin defaults: simultaneously high firm and bank failures. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is 5pp higher than under standard default risk models which underestimate the impact of borrower default on bank solvency.


Running Out of Time (Deposits): Falling Interest Rates and the Decline of Business  Lending, Investment and Firm Creation

I show that the long-term decrease in the nominal short rate since the 1980s contributed to a decline in banks' supply of business loans, firm investment and new firm creation, and an increase in banks' real estate lending. The driving force behind these relationships was the shift in banks’ funding mix from time deposits (CDs) to savings deposits, which was caused by the decrease in the nominal rate. I show that banks finance business lending with time deposits because of their matching interest-rate sensitivity and liquidity. A lower nominal rate reduces the spread on liquid deposits (e.g., savings deposits), leading households to substitute towards them and away from illiquid time deposits. In response to an outflow of time deposits, banks cut the supply of business loans and increase their price. The decrease in business lending leads to reduced investment at bank-dependent firms and a lower entry rate of firms in industries that are highly reliant on external funding. I document these relationships both in the aggregate, and in the cross-section of banks, firms and geographic areas. For identification, I exploit cross-sectional variation in banks' market power and business credit data. I develop a general equilibrium model which captures these relationships and shows that the transmission mechanism I document is quantitatively important.


The Foreign Liability Channel of Bank Capital Requirements (with L. Falasconi, P. Herrero, C. Mendicino)

We examine the effects of tighter capital requirements in a quantitative model of risky financial intermediaries partly funded with foreign currency debt. Setting bank capital requirements at appropriately high levels is crucial to enhance the resilience of banks against sudden losses and the risk of insolvency. As bank default risk declines, the cost of foreign funding decreases, encouraging greater reliance on foreign liabilities. This reveals a novel trade-off in bank capital regulation. On the one hand, higher capital requirements strengthen the resilience of both banks and the broader economy against shocks originating from the banking sector. On the other hand, they increase banks' exposure to potential disruptions in foreign funding. Our findings suggest that in the presence of bank solvency risk, foreign prudential tools, such as capital flow management taxes or foreign exchange rate interventions, are complementary to bank capital requirements in mitigating financial vulnerabilities. Empirical evidence on Peru's transition to higher capital requirements lend support to the foreign liability channel of bank capital requirements.

Publications:

Systemic Risk and Monetary Policy: The Haircut Gap Channel of the Lender of Last Resort (with  M. Jasova, L. Laeven, C. Mendicino, J-L Peydro), Review of Financial Studies, 2024

We show that lender of the last resort (LOLR) policy contributes to higher bank interconnectedness and systemic risk. Using novel micro-level data, we analyze the haircut gap channel of LOLR – the difference between the private market and central bank haircuts. LOLR increases interconnectedness by incentivizing banks to pledge higher haircut gap bonds, especially issued by similar banks and by systemically important banks. LOLR also exacerbates cross-pledging of bank bonds. Higher haircut gaps only incentivize banks, not other intermediaries without LOLR access, to increase bank bond holdings. Finally, LOLR revives bank bond issuance associated with higher haircut gaps.


Policy Uncertainty, Lender of Last Resort and the Real Economy (with M. Jasova and C. Mendicino), Journal of Monetary Economics, 2021   

We show that a reduction in lender of last resort (LOLR) policy uncertainty positively affects bank lending and propagates to investment and employment. We exploit a unique policy that reduced uncertainty regarding the availability of future LOLR funding for banks as a quasi-natural experiment. Using micro-level data on banks, firms and loans in Portugal, we generate cross-sectional variation in banks' exposure to uncertainty and find that the size of the haircut subsidy - the gap between private market and central bank security valuations - plays a key role in the propagation of the shock to lending and the real economy.


Bank Capital in the Short and in the Long Run (with C. Mendicino, K.Nikolov, J.Suarez), Journal of Monetary Economics, 2020

How far should capital requirements be raised in order to ensure a strong and resilient banking system without imposing undue costs on the real economy? Capital requirement increases make banks safer and are beneficial in the long run but also entail transition costs because their imposition reduces credit supply and aggregate demand on impact. In the baseline scenario of a quantitative macro-banking model, 25% of the long-run welfare gains are lost due to transitional costs. The strength of monetary policy accommodation and the degree of bank riskiness are key determinants of the trade-off between the short-run costs and long-run benefits from changes in capital requirements.


Optimal Dynamic Capital Requirements (with  C. Mendicino, K.Nikolov, J.Suarez),  Journal of Money Credit and Banking, 2018

We characterize welfare maximizing capital requirement policies in a quantitative macrobanking model with household, firm, and bank defaults calibrated to Euro Area data. We optimize on the level of the capital requirements applied to each loan class and their sensitivity to changes in default risk. We find that getting the level right (so that bank failure risk remains contained) is of foremost importance, while the optimal sensitivity to default risk is positive but typically smaller than under Basel internal ratings based (IRB) formulas. Starting from low levels, savers and borrowers benefit from higher capital requirements. At higher levels, only savers prefer tighter requirements.

Work in Progress:

A Farewell to ARMs? How the short rate determines the supply of ARMs (with I. Drechsler)

Shadow Banks and the Dynamic Effects of Monetary Policy on Small Business Lending (with M. Gopal, A. Sarto, O. Wang)

Monetary Policy, Labor Income Redistribution and the Credit Channel: Evidence from Matched Employer-Employee and Credit Registers (with  M. Jasova, C. Mendicino, E. Panetti, J-L. Peydro)