Large Banks and the Transmission of Financial Shocks

Abstract

We explore the role of large banks in propagating economic shocks across the U.S. economy. We show that in 2007 and 2008, large banks operating in U.S. counties most affected by the decline in real estate prices contracted their credit to small businesses in counties that were not affected by falling real estate prices. These exposed banks were also more likely to completely cease operations in unaffected counties. By contrast, healthy banks — those not exposed to real estate price shocks — were more likely to expand operations and even to enter new banking markets, capturing market share in both loans and deposits. On average, the market share gain of healthy banks relative to exposed banks was a standard deviation above the long-run historic average market share growth. This offsetting effect was stronger for counties with a larger presence of exposed banks, and it resulted in changes in market share composition that had lasting effects. However, the net effect was negative and counties with a larger presence of exposed banks experienced slower overall growth in deposits, loans, employment, and number of small business establishments. These effects persist for several years after the initial shock.