Monetary Policy, Leverage, and Bank Risk-Taking

Dell'Ariccia, Giovanni; Laeven, Luc; Marquez, Robert

Monetary Policy, Leverage, and Bank Risk-Taking

CEPR Discussion Paper No. DP8199

42 Pages Posted: 31 Jan 2011

See all articles by Giovanni Dell'Ariccia

Giovanni Dell'Ariccia

International Monetary Fund (IMF) - Research Department; Centre for Economic Policy Research (CEPR)

Luc Laeven

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Robert Marquez

University of California, Davis

There are 3 versions of this paper

Date Written: January 2011

Abstract

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: banking, leverage, monetary policy, risk taking

JEL Classification: E44, E58, G21

Suggested Citation: Suggested Citation

Dell'Ariccia, Giovanni and Laeven, Luc A. and Marquez, Robert S., Monetary Policy, Leverage, and Bank Risk-Taking (January 2011). CEPR Discussion Paper No. DP8199. Available at SSRN: https://ssrn.com/abstract=1749820