Monetary policy and bank lending to small firms

This paper presents an empirical test of the balance sheet channel of monetary policy. I take advantage of a panel data set containing nearly all domestic banks to search for an adjustment in lending patterns induced by changes in the stance of monetary policy. I find that in response to monetary policy tightening, banks decrease the proportion of credit extended to high-agency-cost “small” borrowers. Additionally, I provide evidence that this result is in fact driven by a balance sheet effect working on small borrowers rather than on small lenders.

► Banks adjust the mix of their loan portfolios in response to monetary tightening. ► Small US banks exhibit behavior consistent with the balance sheet channel. ► The effect appears to be driven by small borrowers rather than small lenders.