Uninsurable Risks, Bank Defaults and Loan Supply

We use individual U.S. commercial bank balance sheet information to develop stylized
facts about bank behavior in both the cross section and over time. We then build a quant-
itative model of bank behavior taking as exogenous inputs the aggregate and idiosyncratic
components of problem loans, interest rate spreads and deposit shocks, seeking to under-
stand decisions regarding new loans provision, access to wholesale funding and defaults. The
model generates highly procyclical loan supply and banks can curtail new lending very ag-
gressively in response to background risk shocks, such as an increase in bad loans. Bank
failures, though, are strongly countercyclical. Relative to a baseline recession, in a reces-
sion simultaneously accompanied by a temporary freeze in the money market, bank defaults
increase by a factor of three and credit supply drops by 2.5 percentage points more.