The Effects of Changes in Local Bank Health on Household Consumption 
Studies examining the connections between consumption and the financial sector focus primarily on wealth effects, generally concentrating on the role of falling house prices or household financial distress and deleveraging. Although those factors played a role in the 2007–2009 US financial crisis, the linkages between the financial sector and household consumption are broader and more complex.
This paper explores the effect of credit availability on household consumption beyond the standard income and wealth channels. Specifically, it investigates the relationship between credit availability and household consumption using a novel approach to separate credit demand and supply. The paper uses household-level data from the Panel Study of Income Dynamics, along with measures of bank health at the local (usually metropolitan) level. The analysis addresses the potential endogeneity of local bank health by focusing on multi-locational banks, defined as those banks with branches in a given location but whose health is unlikely to be affected by local economic conditions. It further incorporates an innovative and multifaceted approach to identifying households likely in need of bank credit whose consumption is potentially particularly susceptible to changes in credit availability.
This is a substantially revised version of the original paper posted October 2018.
Key Findings
- While a deterioration in local bank health results in lower real (food) consumption, the effects tend to be strongest for constrained households—especially those that have limited liquid assets to serve as a buffer against negative income and expenditure shocks, and are thus most likely to be reliant on bank credit to maintain their desired consumption path.
- This adverse effect on consumption is enhanced if a household has a greater degree of income variability.
- The observed effects appear to be driven by a credit supply channel, as the results are strongest in locations with the worst bank health—consistent with the weakest banks coming under binding regulatory constraints that limit their ability to supply credit.
- The results are robust to alternative approaches to measuring local bank health, including a measure based on bank supervisory data, as well as alternative consumption measures.
Implications
The financial crisis and related contraction in bank credit associated with the Great Recession highlighted the need for policymakers to have a better understanding of the links between the financial sector and real activity. With consumption accounting for roughly 70 percent of US domestic output, the links between household expenditures and the financial markets are particularly relevant.
Because many households—renters as well as homeowners—rely on personal loans, automobile loans, and other consumer loans provided by local bank branches to help smooth their spending over time, a deterioration in local bank health that reduces the availability of such credit can affect a wide range of consumers. Thus, the link between bank financing and household consumption goes well beyond the impact on homeowners operating through home values and mortgage availability.
Abstract
This study investigates the relationship between credit availability and household consumption using a novel approach to separate credit demand and supply. We find that a deterioration in local bank health reduces household consumption, with the strongest effects occurring for households that are more likely to need credit—especially those experiencing a negative income shock and having limited liquid assets. The main contributions of the study are the use of an arguably exogenous measure of local bank health and multifaceted indicators of constrained households. Our findings contribute to the discussion of the linkages between the financial sector and real economic activity.