How Monetary Policy Changes Bank Liability Structure and Funding Cost

Abstract

This paper explores the eff ects of monetary policy shocks on banks' liability structures and funding costs. Banks obtain most of their funding from a combination of demand deposits -- i.e. zero-interest deposits -- and interest-bearing deposits. Using local demographic variations as instruments for banks' liability structures, I measure the impact of monetary policy shocks on each bank's interest-bearing deposit rate as a function of the bank's before-the-shock liability structure. I fi nd that when monetary policy tightens each bank faces an outfl ow of demand deposits. It responds by issuing more interest-bearing deposits, but pays on them an interest rate that increases with the quantity of demand deposits being substituted. This finding supports the existence of the bank lending channel of monetary policy transmission. I also provide evidence that larger banks can substitute funding sources more cheaply than smaller banks, and that demand deposits are less sensitive to monetary policy shocks when the local banking market is more concentrated.