Policy uncertainty and bank’s funding costs: The effects of the financial crisis, Covid-19 pandemic, and market discipline

Abstract

This paper examines the impacts of economic policy uncertainty (EPU) on bank funding costs using the 2001–2021 data of US banks. We document consistent evidence of a negative relationship between EPU and bank funding costs, implying lower bank funding costs during a time of high EPU, consistent with the hypothesis that economic agents tend to reallocate their assets into safer investments, such as bank deposits during high uncertainty. Large banks are likely to benefit most during high EPU when experiencing lower costs of funds compared with other banks, suggesting the “too-big-to-fail” perception of depositors. Cross-sectional analysis indicates that depositors require safer banks to pay lower rates, indicating the existence of market discipline. The cost-decreasing effects of policy uncertainty are less pronounced during the global financial crisis than the Covid-19 crisis.