We show that depositor inattention gives banks deposit market power, explaining incomplete monetary pass-through and generating interest rate exposure that changes sign over the monetary cycle. We present a dynamic deposit-pricing model in which banks trade off current deposit spreads against future deposit base, with inattention dampening spread-sensitive outflows. Empirically, we measure inattention using differential responses to scheduled versus unscheduled income and show that inattentive depositors withdraw less following rate hikes. The data confirm that banks with more inattentive depositors have lower deposit rates, weaker pass-through, and less spread-sensitive outflows. Our calibration quantifies how inattention shapes pass-through and financial stability.

In modern macroeconomics, the marginal propensity to consume out of transitory income shocks is a central object of interest. This paper empirically explores a parallel concept in banking: the marginal propensity to lend out of unsolicited deposit inflows (MPLD). Using county-level dividend payouts as an instrument for deposit inflows, I estimate the MPLD for U.S. banks and show that before QE, the average bank operated “hand-to-mouth” — it transformed approximately every dollar of deposit inflow into new loans, consistent with tight liquidity constraints. However, since then, the MPLD has dropped to 0.37. Moreover, the MPLD decreases in banks’ cash-to-asset ratio and measures of deposit market power. The findings suggest that the QE-induced abundant reserves regime significantly relaxed liquidity constraints for the majority of banks, but did not eliminate them entirely.

We examine the effects of tighter capital requirements in a quantitative model of risky financial intermediaries partly funded with foreign currency debt. Setting bank capital requirements at appropriately high levels is crucial to enhance the resilience of banks against sudden losses and the risk of insolvency. As bank default risk declines, the cost of foreign funding decreases, encouraging greater reliance on foreign liabilities. This reveals a novel trade-off in bank capital regulation. On the one hand, higher capital requirements strengthen the resilience of both banks and the broader economy against shocks originating from the banking sector. On the other hand, they increase banks’ exposure to potential disruptions in foreign funding. Our findings suggest that in the presence of bank solvency risk, foreign prudential tools, such as capital flow management taxes or foreign exchange rate interventions, are complementary to bank capital requirements in mitigating financial vulnerabilities. Empirical evidence on Peru’s transition to higher capital requirements lend support to the foreign liability channel of bank capital requirements.