Bank equity and the monetary transmission mechanism

The implementation of the Basle Capital Accord in the United States in 1991 focused significant attention on the influence of bank equity capital on bank lending and real activity. My dissertation investigates the importance of bank equity for the propagation of economic shocks, in particular interest rate shocks and oil price shocks. This thesis takes advantage of a dataset, the Reports of Condition and Income (the Call Reports) that is highly disaggregated in two respects---by bank and by loan type.;Chapter I of the dissertation employs a vector autoregression (VAR) designed for a regional system to examine the behavior of bank equity and bank loans in response to shocks that raise interest rates---an interest rate shock (monetary contraction) and an oil price shock. Clearly, both of these shocks lower real activity, which also affects bank equity (e.g., through loan defaults) and bank loans. For my purposes, however, I am interested in isolating the direct impact of the higher interest rates on the bank variables, excluding the indirect impact of the increase in interest rates on bank variables through its effect on real activity. Results suggest that bank equity plays an important role in explaining the drop in real activity that is observed. Results also show that during periods of higher interest rates there is a strong substitution out of real estate loans and into commercial and industrial (C&I) loans that cannot be explained by changes in the demand of these loan components caused by changes in real activity.;Chapter II examines in more detail ways in which bank equity capital may affect state-level real activity. Using the empirical framework proposed by Van den Heuvel (2001), changes in the interest rate are allowed to differ across states but only as a function of the capital-to-asset ratio. This provides a framework in which the importance of the health and stability of financial institutions (represented by the capital-to-asset ratio) can be evaluated.;The final chapter examines the comovement between prices and real activity in the G7 countries during the postwar period using VAR forecast errors and frequency domain filters.