Camelia Minoiu, Andres Schneider, and Min Wei
Working Paper 2023-14
September 2023

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We provide evidence on the effect of the slope of the yield curve on economic activity through bank lending. Using detailed data on banks' lending activities coupled with term premium shocks identified using high-frequency event study or instrumental variables, we show that a steeper yield curve associated with higher term premiums (rather than higher expected short rates) boosts bank profits and the supply of bank loans. Intuitively, a higher term premium represents greater expected profits on maturity transformation, which is at the core of banks' business model, and therefore incentivizes bank lending. This effect is stronger for ex-ante more leveraged banks. We rationalize our findings in a portfolio model for banks.

JEL classification: E44, E52, E58

Key words: predictive power of the yield curve, term spread, term premium, bank lending, bank probability, event study, instrumental variable

The authors thank Valentina Bruno, Bill English, Emi Nakamura, Bill Nelson, Pascal Paul, Enrico Sette (discussant), Hiroatsu Tanaka, Skander Van den Heuvel, Annette Vissing-Jorgensen, Jonathan Wright, Yu Xu, and conference and seminar participants at the Swiss Winter Conference on Financial Intermediation and the Federal Reserve Board for helpful comments and suggestions. They thank Don Kim and Marcel Priebsch for sharing their term premium series. The authors also thank Jack Spira, Jacob Bochner, Alejandro Guillot, and Stephanie Sezen for research assistance at different stages of the project. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Camelia Minoiu, Federal Reserve Bank of Atlanta; Andres Schneider, Federal Reserve Board; or Min Wei, Federal Reserve Board.

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