Why does the yield curve predict GDP growth? The role of banks

We show that the slope of the yield curve affects bank lending and economic activity through an "expected bank profitability channel." Using detailed banking data and term premium shocks identified via instrumental variables or event studies, we show that a steeper yield curve-when driven by higher term premiums rather than higher expected short rates-increases bank profits and loan supply. Intuitively, a higher term premium raises the expected returns from maturity transformation-a core banking activity- thereby incentivizing bank lending. This effect is more pronounced for banks with higher leverage. We interpret these findings using a simple bank portfolio model.