Risk and Macro Finance Alexi Savov (NYU Stern)
'Banking on Deposits: Maturity Transformation without Interest Rate Risk'
We show that in stark contrast to conventional wisdom maturity transformation does not expose banks to significant interest rate risk. Aggregate net interest margins have been near-constant from 1955 to 2015, despite substantial maturity mismatch and wide variation in interest rates. We argue that this is due to banks' market power in deposit markets. Market power allows banks to pay deposit rates that are low and relatively insensitive to interest rate changes, but it also requires them to pay large operating costs. This makes deposits resemble fixed-rate liabilities. Banks hedge them by investing in long-term assets whose interest payments are also relatively insensitive to interest rate changes. Consistent with this view, we find that banks match the interest rate sensitivities of their expenses and income one for one. This relationship is robust to instrumenting for expense sensitivity using geographic variation in market power. Also consistent, we find that banks with lower expense sensitivity hold assets with substantially longer duration. Our results provide a novel explanation for the coexistence of deposit-taking and maturity transformation.
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