Local Lending Specialization and Monetary Policy

Abstract

We explore how banks’ local lending market specialization shapes their loan supply in response to monetary policy changes. Using data from the U.S. mortgage market, we find that when the Fed funds rate declines, banks increase new mortgage lending growth by more in markets where they are more specialized, i.e. lent more in the past, relative to other markets. This result holds when controlling for local lending opportunities and bank-year level heterogeneity. We also document relevant aggregate county-level and bank-level implications of this channel. After a decrease in the Fed funds rate (i) mortgage markets with more exposure to specialized banks experience a higher increase in aggregate new mortgage supply and house price growth and (ii) banks increase (decrease) their average specialization (diversification) growth. We provide theoretical and empirical evidence in line with heterogeneous lending costs across markets, related to informational asymmetries, being a relevant driver of the results. Our findings suggest that bank’s local specialization is an important determinant for the transmission of monetary policy to the economy and that it is itself affected by monetary policy changes.

Publication
Job Market Paper