Monetary Policy and Excessive Bank Risk Taking

33 Pages Posted: 27 Oct 2011

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2010


This paper shows that a rate hike has countervailing effects on banks’ risk appetite. It reduces risk when the debt burden of the banking sector is modest. We model a regulator whose trade-off between bank risk and credit supply is derived from a welfare function. We show that the regulator cannot optimally neutralize the welfare effects that the interest rate has through bank incentives. The larger the correlation between banks’ projects, the more important the role for monetary policy. In a dynamic setting, not internalizing bank risk leads a monetary authority to keep rates low for too long after a negative shock.

Keywords: Monetary policy, Financial stability, Maturity mismatch, Leverage, Regulation

JEL Classification: E43, E52, E61, G01, G21, G28

Suggested Citation

Agur, Itai and Demertzis, Maria, Monetary Policy and Excessive Bank Risk Taking (December 1, 2010). De Nederlandsche Bank Working Paper No. 271. Available at SSRN: or

Itai Agur (Contact Author)

IMF ( email )

700 19th Street NW
Washington, DC 20431
United States


Maria Demertzis

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210

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