Banks' Liability Structure and Mortgage Lending During the Financial Crisis

Abstract

We examine the impact of banks' exposure to market liquidity shocks through wholesale funding on their supply of credit during the financial crisis. We focus on mortgage lending since a comparison across heterogeneous categories of credit could be easily tainted by confounding demand factors. We exploit the time variation in market liquidity and the cross-section variation in wholesale funding by banks to study relative changes in bank rejection rates using comprehensive loan-level data on mortgage applications while controlling for bank, borrower, and regional characteristics. Banks that were more reliant on wholesale funding curtailed their credit significantly more than retail-funded banks during the crisis. The demand for mortgage credit, on the other hand, declined evenly across wholesale and retail banks. We also exploit the discrete fall in loan liquidity of jumbo loans (loans that cannot be purchased by the GSEs) and show that the relative decline in the supply of credit by wholesale banks was significantly more pronounced above the jumbo cutoff. This and several other robustness checks, including a matching exercise in which we eliminate imbalances in observable applicant characteristics between these banks, provide strong evidence that the crisis has led to a sharper contraction in the supply of credit by wholesale funded banks and highlight the role of liquidity conservation. We explore the aggregate implications of our findings by exploiting the heterogeneity in mortgage funding across U.S. MSAs and find that wholesale funding was a strong and significant predictor of a sharper decline in overall mortgage credit at the MSA level.