Shengxing Zhang from Carnegie Mellon University will present "Excess Loan Premium and Business Cycle Fluctuations"

Abstract: Default risks cannot explain all the spread between the loan rate and the interbank rate. The excess loan premium is sizable and countercyclical. We study the excess premium and its aggregate implications by introducing search frictions between banks and their customers, and incomplete competition between banks to a benchmark financial accelerator model, Bernanke et al. (1999). We find that search frictions between intermediaries and their customers can intensify the classical financial accelerator mechanism, the feedback between entrepreneurs’ net worth and their borrowing costs. Entrepreneurs’ borrowing costs increase when they need financing the most or when the loan market is illiquid. Depositors’ returns from savings can decrease when the deposit market is illiquid. The excess loan premium, because of the incomplete competition between banks, correlates with the amplification mechanism from search frictions in both the loan and deposit markets.