What online banks can teach us about monetary policy
Financial technology has been reshaping commercial banking. It has the potential to radically alter the transmission of monetary policy by lowering search costs and expanding bank markets.
In their new paper, the Risk Institute’s Academic Director and Professor of Finance, Isil Erel, and her coauthors study the reaction of online banks to changes in federal fund rates.
Along with Jack Liebersohn of the University of California, Irvine, and Constantine Yannelis and Sam Earnest, of the University of Chicago, the researchers find that these banks increase rates that they offer on deposits significantly more than traditional banks do. A 100-basis-points increase in federal fund rate leads to a 30-basis-points larger increase in rates of online banks. Consistent with the rate movements, online bank deposits experience inflows, while traditional banks experience outflows during monetary tightening of 2022.
The findings, which have been presented at the Federal Reserve Board, are consistent across banking markets of different competitiveness and demographics.
Why is this research important? Banking systems are the main channels through which monetary policy transmission to market rates happens. Recent technological advances that have revolutionized traditional banking services, however, have the potential to radically alter the monetary process as well. Individuals can now transfer funds via mobile devices and compare investments online, which dramatically lowers search costs, weakens banking relationships, and increases geographic scope and financial market competitiveness. The size of regulated commercial banks that fully operate online, typically with only one administrative branch, grew by more than 25 times in the 2000s.
The findings shed new light on the role of online banks in interest rate pass-through and deposit channel of monetary policy. The growing utilization of online banks and financial technology in general, will likely change the efficacy of central bank policy in the future.
