Excessive Bank Risk Taking and Monetary Policy

34 Pages Posted: 20 Aug 2012

Date Written: August 13, 2012


Why should monetary policy 'lean against the wind'? Can’t bank regulation perform its task alone? We model banks that choose both asset volatility and leverage, and identify how monetary policy transmits to bank risk. Subsequently, we introduce a regulator whose tool is a risk-based capital requirement. We derive from welfare that the regulator trades off bank risk and credit supply, and show that monetary policy affects both sides of this trade-off. Hence, regulation cannot neutralize the policy rate’s impact, and monetary policy matters for financial stability. An extension shows how the commonality of bank exposures affects monetary transmission.

Keywords: macroprudential, leverage, supervision, monetary transmission

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

Suggested Citation

Agur, Itai and Demertzis, Maria, Excessive Bank Risk Taking and Monetary Policy (August 13, 2012). ECB Working Paper No. 1457. Available at SSRN: https://ssrn.com/abstract=2128478

Itai Agur (Contact Author)

IMF ( email )

700 19th Street NW
Washington, DC 20431
United States

HOME PAGE: http://itaiagur.weebly.com/

Maria Demertzis

Bruegel ( email )

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

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