Costly External Financing and Monetary Policy Transmission: Evidence from a Natural Experiment∗ Emily Williamsy April 20, 2020 Abstract I provide new evidence that large and small banks have different external financing costs, which generates cross sectional variation in a deposits market pricing power channel of monetary policy transmission. I do so by exploiting a natural experiment using anti-trust related bank branch divestitures. In these divestitures branches are transferred from large to small banks such that the branches are largely preserved and market structure remains unchanged. Consistent with the existence of capital market imperfections at small banks, I find that { holding market concentration constant { lending declines in areas local to branches newly owned by small banks, and deposit rates increase by more, when interest rates increase. My results are confirmed with geographically granular tests utilizing the entire sample of data, and indicate that financing frictions still matter for the transmission of monetary policy through banks. ∗I thank Stefan Lewellen, Adi Sunderam, Sam Hanson, Victoria Ivashina, Christopher Hennessy, Francisco Gomes, Vikrant Vig, and seminar participants at LBS, Yale, HBS, The Tuck School of Business, London School of Economics, Imperial, INSEAD, MIT, Kellogg, Carnegie Mellon, Columbia Business School, The Wharton School, Darden, Exeter, the New York Fed, The McCombs School of Business, The Federal Reserve Board, The FDIC, The Federal Reserve Bank of Boston, and Duke for helpful comments and discussions. I also thank Hoai-Luu Nguyen for providing data and thank London Business School and Harvard Business School for providing financial support.
[email protected] 1 1. Introduction In the traditional bank lending channel of Kashyap and Stein (1995, 2000) { KS hereafter { when the Fed raises rates, it does so through open market operations that reduce the volume of reserves in the banking system.