Understanding bank and non-bank credit cycles: a structural exploration
Summary
Focus
Increased lending by non-banks in the last three decades has significantly changed the US financial intermediation system. Additionally, non-banks may affect financial stability, both directly and through their linkages with the banking system. This paper asks what has driven the rapid rise of non-bank intermediation, and how these drivers relate to those for traditional bank credit. It also investigates their combined effects on the economy.
Contribution
We use an estimated DSGE model with two types of financial intermediary: banks and non-banks and subject to various economy-wide disturbances – such as technological progress, aggregate demand, and financial shocks – and sector-specific shocks that directly impact only bank or non-bank lending. The paper offers new insights into the role of macro versus financial shocks in driving economic fluctuations. By explicitly modelling two different types of financial intermediary, an important role for sectoral financial shocks is uncovered, a finding overlooked by the previous literature.
Findings
The paper finds a quantitatively dominant role for sectoral financial shocks in driving bank and non-bank lending growth. More than 70% of bank and non-bank lending growth is driven by sectoral shocks. Shocks to the net worth of entrepreneurs who borrow from banks and non-banks are particularly important. Historical decompositions show that shocks to the net worth of entrepreneurs are important in understanding the deep decline in bank lending growth in the early 1990s and the dynamics of bank and non-bank lending entering into the Great Recession. Together, they account for around half of the declines in bank and non-bank lending growth during those two periods.
Abstract
We explore the structural drivers of bank and nonbank credit cycles using a medium-scale DSGE model with two types of financial intermediation. We posit economy-wide and sectoral disturbances in both macro and financial sectors. We estimate that sectoral shocks to the balance sheets of entrepreneurs are important for fluctuations in bank and nonbank credit growth at the business cycle frequency. Economy-wide entrepreneurial risk shocks gain predominance for explaining the lower frequency co-movement between the two series. Macro shocks play very little role in explaining financial cycles.
JEL Codes: E3, E44, G01, G21
Keywords: banks, non-banks, financial shocks, credit cycles, leverage, DSGE models, capital requirements