Monetary Policy, Leverage, and Bank Risk-Taking
39 Pages Posted: 16 Jan 2011
Date Written: January 14, 2011
The recent global financial crisis has ignited a debate on whether easy monetary conditions can lead to greater bank risk-taking. We study this issue in a model of leveraged financial intermediaries that endogenously choose the riskiness of their portfolios. When banks can adjust their capital structures, monetary easing unequivocally leads to greater leverage and higher risk. However, if the capital structure is fixed, the effect depends on the degree of leverage: following a policy rate cut, well capitalized banks increase risk, while highly levered banks decrease it. Further, the capitalization cutoff depends on the degree of bank competition. It is therefore expected to vary across countries and over time.
Keywords: monetary policy, leverage, risk taking, banking crises
JEL Classification: E44, E58, G21
Suggested Citation: Suggested Citation