Essays on Banking and the Macroeconomic Effects of Financial Intermediation

Abstract

How did bank capital affect bank lending in the past financial crisis? I argue in this paper that small banks amplified the recession through a bank capital channel and that Too-Big-To-Fail (TBTF) policies helped the economy avoid a deeper recession by reducing the effects of this channel in the case of big banks. In my model, when the banking sector is hit with a negative systemic shock, small banks contract their lending during the recession. However, big banks' equity is protected by TBTF policies, so they do not have to contract lending as much. This helps explain the banks' heterogeneous responses to the recent financial crisis. Despite the benefits to the overall economy, there are important wealth redistribution consequences. In particular, households are worse o because they have to bear the costs of the TBTF policies.