The Effect of Dealing in Securities on Lending at Commercial Banks

The Effect of Dealing in Securities on Lending at Commercial Banks Public Deposited

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Abstract

This study empirically examines the effect on lending of the change in bank regulation in 1996, when commercial banks were allowed to increase their dealing in securities. It documents the decline in loan growth rates at the affected dealer banks compared to unaffected banks. In particular, affected banks restricted their supply of lending by increasing denial rates on mortgages after the change. These effects can be explained by the competition for limited funding between lending and dealing in securities in the presence of credit constraints. Also, this research demonstrates that dealer banks shift funds from lending to market-making during periods of high volatility. This occurs because of the increased demand for liquidity provision by market-makers. Consistent with this explanation, I find higher risk-adjusted gross trading returns at dealer banks at those times.

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