Geographic networks and spillovers between banks

Abstract

This paper identifies geographic linkages as novel linkages that can transmit negative shocks from one bank to another. I consider linkages between banks that engage in home lending in the same geographic area. Exploiting home price changes initiated by the Great Recession and heterogeneity in such changes across geographic areas to capture variations in a bank's exposure to negative shocks, I show that a bank contracts lending more if its linkages are more shocked. Results suggest investor-runs as the underlying mechanisms of spillovers: Because similar banks lend in similar markets, investors lose confidence on the quality of banks that are geographically linked with shocked banks and run on them, thus resulting in banks reducing lending.