Productivity shocks, capital intensities, and bank interest rates

Abstract

This paper proposes a real business cycle model in which banks are focused on their traditional role of providing loans to industrial corporations and face significant resource costs to provide financial services. We find that resource costs explain a large share of bank interest margins, which generates a floor for the interest rate on loans. Idiosyncratic shocks hitting the banking industry generate non-negligible effects on the rest of the economy, but their impact on wages and the rental rate of capital is rather small. The pro-cyclicality of the banking sector is therefore unlikely to feed back strongly to economic activity in the absence of large wealth effects on household. Positive productivity shocks hitting the industrial sector induce sizable increases of the rate on loans and sharp increases in the total hours worked in the banking system. Economy-wide negative technological shocks do indeed generate losses in the banking industry that are not only substantial but are proportionally larger than in the industrial sector. Large banking crises may emerge as a consequence of negative technological shocks hitting bank borrowers.