This essay is based on the working paper “The Secular Decline of Bank Balance Sheet Lending” by Greg Buchak, Gregor Matvos, Tomasz Piskorski, and Amit Seru.
This paper delves into the profound changes in the traditional model of bank balance sheet intermediation, historically characterized by banks funding informationally sensitive loans to borrowers through the issuance of demandable deposits to savers. This conventional framework has been pivotal in shaping macroprudential policy, guiding monetary policy decisions, and underpinning financial interventions such as bank bailouts. However, our analysis reveals a significant transformation in this model over the last fifty years. Here, we document this decline, explore the underlying economic forces driving these changes, and discuss the implications for the financial system and regulatory practices.
Traditionally, banks operated under a model in which the issuance of deposits directly funded loans. This relationship formed the core of financial intermediation, influencing a broad spectrum of economic activities and policy formulations. Our study starts by highlighting a key trend: the share of “informationally sensitive lending”—where lending decisions are heavily based on specific, nuanced information regarding borrowers—peaked at approximately 60 percent in the early 1970s and has since declined to approximately 35 percent. Instead, there has been a marked shift toward arm’s-length transactions, exemplified by the rise in private credit intermediation through the securitization market. This shift is evidenced by a growth in practices where lenders originate loans only to sell them off as debt securities.
Moreover, the decline in bank balance sheet lending is not confined to loans eligible for securitization by government-sponsored entities (GSEs). There has also been a noticeable decrease in loans that do not qualify for such guarantees. There has been a parallel shift on the side of savers. The proportion of household savings held in the form of bank deposits is almost half what it was, reduced from 22 percent to approximately 13 percent. Savers increasingly gravitate toward alternative financial instruments, such as securitized credit or Treasury securities.
Additionally, there has been a fundamental shift within banks themselves. In 1970, loans accounted for approximately 70 percent of a bank’s asset portfolio. By 2023, this figure shrank to 55 percent. Remarkably, this substantial shift in the composition of bank assets has not been accompanied by dramatic changes in the pricing of deposits, loans, and credit securities. The observed spreads remain largely stable, thereby suggesting that the transformation in the types and structures of assets held by banks has not drastically altered consumers’ borrowing costs.
Our analysis identifies three primary forces that drive these shifts:
- Technological and institutional changes: The last few decades have seen significant advancements in financial technologies and the institutional framework surrounding financial markets. The increase in securitization, supported by automation in loan origination and underwriting and the widespread adoption of the FICO score, has streamlined the process of loan sales and reduced the dependence on traditional, informationally sensitive lending practices. Additionally, the development of government-supported debt securities markets, such as those for agency mortgage-backed securities (MBS), has further diminished the relative importance of bank balance sheet lending.
- Changes in saver preferences: The latter part of the twentieth century witnessed transformative changes in how savers allocate their resources. The emergence of money market funds, the modernization of pension funds, and an increased international appetite for US assets have all tilted preferences away from traditional bank deposits toward more diversified and often higher-yielding debt securities. These changes reflect a broader shift in risk tolerance and investment strategy among savers.
- Regulatory evolution: The regulatory landscape governing the banking sector has undergone substantial reforms. The deregulation trends, including the relaxation of interstate banking restrictions and responses to financial crises such as the global financial crisis, have altered the economic fundamentals of banking. Changes in regulation have impacted the costs and benefits associated with bank balance sheet lending and influenced the strategic decisions of financial institutions in terms of their funding structures and asset compositions.
Using a quantitative model, we decompose these trends to assess their impact on the financial landscape. This model considers alternative savings technologies and different borrowing mechanisms, recognizing that various forms of credit are imperfect substitutes for one another (including the move toward more informationally insensitive lending practices by banks and “shadow” banks, which operate under the originate-to-distribute model).
We discover the following aspects in our analysis. Declines in securitization costs account for changes in aggregate lending quantities. Savers, rather than borrowers, are the main drivers of the size of bank balance sheets. Implicit bank costs and subsidies explain the changing composition of bank balance sheets. Together, these forces explain the reduction in the overall share of informationally sensitive bank lending in credit intermediation.
We conclude by evaluating how these shifts influence the financial sector’s response to macroprudential policies such as capital and liquidity regulation. The transformation in banking and credit intermediation suggests a reduced sensitivity to changes in capital requirements compared to that of earlier decades, underscoring the need for financial regulation to adapt to the evolving dynamics of financial markets.
Our paper contributes to the extensive literature on financial intermediation, linking changes in technology, saver preferences, and regulation to the structural evolution of the banking sector and its implications for financial stability and regulatory policy.
Read the full working paper here.
Amit Seru is a senior fellow at the Hoover Institution and the Steven and Roberta Denning Professor of Finance at the Stanford Graduate School of Business.
This essay is part of the Financial Regulation Research Brief Series. Research briefs highlight the policy-relevant features of research on financial systems, including the impact of financial regulations on economic growth, stability, and other factors shaping living standards.
