Geographic Networks and Spillovers between Banks

I identify a novel interconnection that forms between banks that engage in home lending in the same geographic region and show that it facilitates bank-to-bank spillovers. Exploiting home price changes initiated by the shock of the Great Recession and heterogeneity in such changes across markets to capture variations in negative shocks to banks via market exposure, I find that a bank contracts lending more if its linkages are more shocked. Results suggest investor-runs as the underlying spillover mechanism: Because similar banks lend in similar markets, investors lose confidence on the quality of banks that are geographically linked with shocked banks and run on them, thus resulting in banks to contract lending.