9512649 Kashyap The goal of this project is to explore, along both theoretical and empirical lines, the role of banks in the transmission of monetary policy. On the theoretical front, the project aims to develop a new fully specified model of the banking sector that demonstrates how the adverse selection problems banks face in raising uninsured, non-deposit external financing can affect the determination of interest rates on both bank loans and open-market securities. The model will show how the same sort of capital market frictions that can make non-financial firms spending overly sensitive to cash flow can influence bank portfolio decisions and the equilibrium level of interest rates. Empirically, bank-level data will be used to test the model. One of the most useful aspects of the model is that it makes a number of clear-cut cross-sectional predictions. For example, if a set of banks can be identified that are a priori more likely to be constrained by adverse selection problems in raising non-deposit finance, the model predicts that the lending behavior of these banks should be particularly sensitive to changes in the stance of Monterey policy. There are potentially a number of variables that can be used as proxies for such constraints, including bank size, "excess" cash and securities on hand, levels of capital, etc. It should be emphasized that the bank-level data set that this project constructs will be unique in terms of its coverage over time and across banks. Therefore, in addition to the narrow focus on monetary transmission, the data set will no doubt very useful in addressing a number of other related issues.
