Three essays on financial intermediation

Abstract

This thesis aims to advance our understanding on several aspects of modern credit markets. The first chapter explores the implications of separating retail and investment banking. Studying the introduction of UK ring-fencing requirements, we uncover a previously undocumented mechanism through which structural separation affects the lending behaviour of universal banks: by preventing universal banks from using retail deposits to fund capital market activities, structural separation incentivises banks to rebalance away from global corporate lending and towards retail mortgage lending. This rebalancing has knock-on effects on the wider retail banking system, with ambiguous implications for competition and financial stability. As they redirect the benefits of deposit funding towards the retail mortgage market, large universal banks outcompete smaller banks, leading to an increase in market concentration. Smaller banks respond by increasing the riskiness of their lending. The second chapter studies the role of nonbank lenders in the international transmission of US monetary policy. We show that nonbank lenders weaken US monetary policy spillovers. Specifically, when US monetary policy tightens, nonbank lenders increase the supply of syndicated dollar credit to non-US borrowers, relative to banks. The substitution from bank to nonbank credit is stronger for riskier borrowers and those in emerging markets. However, this increased risk-taking is not driven by more fragile nonbank lenders, nor associated with zombie lending. The credit substitution also has real effects, as borrowers with existing relationships with nonbank lenders relatively increase total debt, investment, and employment when US monetary policy tightens. Taken together, our results suggest that nonbank lenders reduce the volatility in capital flows and economic activity associated with the global financial cycle. The third chapter turns to the corporate bond market. We study the impact of quantitative easing (QE) on market liquidity, and develop a novel econometric approach to address a reverse causality problem inherent in this question. Using the Bank of England’s Corporate Bond Purchase Scheme (CBPS) as our laboratory, we find robust evidence that QE purchases improve the liquidity of purchased bonds.