Bewley Banks

Abstract:

We document new facts on the cross-sectional and business cycle properties of bank size and market power, highlighting the unconditional counter-cyclicality of asset markups and pro-cyclicality of deposit markups. We then develop a dynamic general equilibrium model with heterogeneous financial intermediaries, incomplete markets, two-sided market power, and aggregate uncertainty. The model generates a bank net worth distribution fluctuation problem analogous to the canonical Bewley-Huggett-Aiyagari-Imrohoglu environment. We show that non-separable preferences and aggregate TFP shocks produce empirically-consistent cyclicality of markups and key financial aggregates. Time-varying bank market power and a precautionary lending motive both dampen aggregate responses to exogenous shocks. Counter-cyclical idiosyncratic bank return risk, however, is a significant source of business cycle amplification, especially in the case of banking crises.