Do Banks Pass Through Credit Expansions? The Marginal Profitability of Consumer Lending During the Great Recession

We examine the ability of policymakers to stimulate household borrowing and spending during the Great Recession by reducing banks’ cost of funds. Using panel data on 8.5 million U.S. credit card accounts and 743 credit limit regression discontinuities, we estimate the marginal propensity to borrow (MPB) for households with different FICO credit scores. We find substantial heterogeneity, with a $1 increase in credit limits raising total unsecured borrowing after 12 months by 59 cents for consumers with the lowest FICO scores (≤ 660) while having no effect on consumers with the highest FICO scores (> 740). We use the same credit limit regression discontinuities to estimate banks’ marginal propensity to lend (MPL) out of a decrease in their cost of funds. For the lowest FICO score households, higher credit limits quickly reduce marginal profits, limiting the pass-through of credit expansions to those households. We estimate that a 1 percentage point reduction in the cost of funds raises optimal credit limits by $127 for consumers with FICO scores below 660 versus $2,203 for consumers with FICO scores above 740. We conclude that banks’ MPL is lowest exactly for those households with the highest MPB, limiting the effectiveness of policies that aim to stimulate the economy by reducing banks’ cost of funds.

NBER Working Paper No. 21567