HOW DO BANKS RESPOND TO INCREASEDFUNDING UNCERTAINTY?

This paper presents a simple model of risk-averse banks that face uncer-tainty over funding conditions in the money market. It shows when increasedfunding uncertainty causes interest rates on loans and deposits to rise, whilebank lending and bank pro…tability fall. It also …nds that funding uncertaintytypically dampens the rate of pass-through from changes in the central bank´spolicy rate to market interest rates. These results help explain observed bankbehaviour and reduced e¤ectiveness of monetary policy in the 2007/9 …nancialcrisis. Funding uncertainty also has strong implications for consumer welfare,and can turn deposits into a loss leaderfor banks....