The Passthrough of Treasury Supply to Bank Deposit Funding
The U.S. Treasury market and the banking system are often discussed separately. One is about government borrowing. The other is about deposits and lending. This paper shows that they are directly connected: when the government issues more Treasury securities, it can crowd out bank deposits and affect bank lending.
The mechanism starts with the fact that Treasuries and deposits both provide liquidity services. Deposits are useful because they are safe, liquid, and connected to payment services. Treasuries are useful because they are safe, liquid, and easy to trade or pledge as collateral. Investors do not view them as identical, but they are substitutes. When Treasury supply rises, investors have more public safe assets available, and their demand for bank deposits falls.
The effect depends on deposit market competition. Banks have market power in deposit markets because deposits are differentiated: branches, services, relationships, and convenience all matter. In less competitive markets, banks can adjust deposit spreads more. In more competitive markets, deposit quantities respond more. Therefore, the same increase in Treasury supply can produce larger deposit outflows in more competitive deposit markets.
We test this using branch-level and bank-level data. The empirical strategy compares deposit outcomes across branches of the same bank that operate in markets with different levels of local competition. This helps isolate the role of deposit competition from broader bank-level shocks. We also distinguish the effect of Treasury supply from monetary policy, because the two operate through different margins.
The findings show that larger Treasury supply crowds out deposits, especially in more competitive deposit markets. It also affects the composition of bank funding. Wholesale deposit markets are more competitive than retail deposit markets, so Treasury supply disproportionately reduces wholesale funding. Since wholesale funding can be more runnable, this channel may improve some dimensions of bank funding stability.
But there is also a real-economy cost. Deposits are an important source of bank funding. When Treasury supply reduces deposits, banks can curtail lending. The paper finds effects on small business lending and mortgage lending. Treasury issuance therefore does not only affect bond markets; it can pass through to local credit supply.
The paper contrasts this channel with the deposits channel of monetary policy. Higher policy rates affect banks' supply of deposits and have stronger effects in more concentrated markets. Treasury supply mainly affects investors' demand for deposits and has stronger quantity effects in more competitive markets. This distinction matters because fiscal expansion and monetary policy often move together during downturns. Their effects on bank deposits can differ and sometimes interact.
The takeaway is that government debt is not financially neutral plumbing. Treasuries compete with bank deposits as safe and liquid assets. When the Treasury market grows, banks may lose some deposit funding, and that can influence lending to households and firms. The effect is not uniform; it depends on the competitiveness of local deposit markets and the type of deposits involved.
This matters for current debates about high public debt. The question is not only whether investors will buy the new Treasuries. It is also what they will buy less of when they do. If the answer is bank deposits, then Treasury issuance can reshape bank funding and credit supply. Fiscal policy, safe-asset supply, and banking conditions are part of the same system.