Monetary Policy, Leverage, and Bank Risk-Taking

37 Pages Posted: 1 Feb 2011

See all articles by Luc Laeven

Luc Laeven

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

Giovanni Dell'Ariccia

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

Robert Marquez

University of California, Davis

Multiple version iconThere are 3 versions of this paper

Date Written: December 2010

Abstract

We provide a theoretical foundation for the claim that prolonged periods of easy monetary conditions increase bank risk taking. The net effect of a monetary policy change on bank monitoring (an inverse measure of risk taking) depends on the balance of three forces: interest rate pass-through, risk shifting, and leverage. When banks can adjust their capital structures, a monetary easing leads to greater leverage and lower monitoring. However, if a bank's capital structure is fixed, the balance depends on the degree of bank capitalization: when facing a policy rate cut, well capitalized banks decrease monitoring, while highly levered banks increase it. Further, the balance of these effects depends on the structure and contestability of the banking industry, and is therefore likely to vary across countries and over time.

Keywords: Banks, Capital, Central bank policy, Credit risk, Economic models, Financial intermediation, Monetary policy, Risk management

Suggested Citation

Laeven, Luc A. and Dell'Ariccia, Giovanni and Marquez, Robert S., Monetary Policy, Leverage, and Bank Risk-Taking (December 2010). IMF Working Papers, Vol. , pp. 1-36, 2010. Available at SSRN: https://ssrn.com/abstract=1751388

Luc A. Laeven (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Giovanni Dell'Ariccia

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8135 (Phone)
202-623-4352 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Robert S. Marquez

University of California, Davis ( email )

One Shields Avenue
Davis, CA 95616
United States

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