Bank lending and interest-on-excess-reserves: Effects of Central Banks on the global credit supply

How do banks behave when the opportunity cost of keeping overnight liquidity is less? In this paper, I study the adoption of unconventional monetary policy with interest-on-excess-reserves (IOER) in the pre-2008-crisis period in Australia, Canada, Europe, Japan, and the United Kingdom. Exploiting this cross-border shock to the monetary design, I show that global banks move liquidity to their home countries and reduce their cross-border credit supply when their home Central Bank introduces a deposit facility that remunerates overnight excess reserves. The credit supply reduction is focused on the smaller, less profitable, and more illiquid branches of the affected banks. Thus, a reduction in the opportunity cost of overnight liquidity has a contractionary impact on the credit supply and results in global macroeconomic spillovers. The results suggest that banks cut lending when the Central Bank is a risk-free borrower and have broad implications for the design of monetary policy, payment systems, and liquidity regulations.