Breaking the ceiling: Interest rate deregulation and liquidity creation

This paper examines how the removal of binding usury limits affects bank liquidity creation, lending composition, competition, and monetary policy transmission. Leveraging the 1999 Gramm–Leach–Bliley Act’s elimination of Arkansas’ interest rate ceiling, we find heterogeneous effects by bank size: large banks increased liquidity creation, while small banks reduced it. Deregulation also reshaped loan portfolios, with small banks expanding individual lending and large banks increasing commercial, industrial, and mortgage loans. The removal of the rate cap intensified competition, reducing market power, yet had no significant long-term impact on bank stability or macroeconomic conditions. We also document a substantial amplification of the lending channel of monetary policy post-deregulation. These findings advance the literature by connecting interest rate (de)regulation to core banking functions and the effectiveness of monetary policy.