Trading Channel and Transmission of Monetary Policy Shocks
38 Pages Posted: 29 Oct 2014
Date Written: October 28, 2014
With banks’ business model changing from "originate and hold" to "originate, repackage, and sell", our paper examines whether a trading channel exists besides capital and lending channels, and whether this channel has weakened the effectiveness of monetary policy on the banks’ capital and lending channels. Using a panel vector autoregression (VAR) framework for a sample of 580 U.S. commercial banks during 2003Q1 to 2012Q4, our findings confirm the existence of a trading channel. That is, when banks’ asset funding is restricted due to an increase in the cost of borrowing, banks tend to reduce lending, liquidate their securities holdings, and freeze asset sales and securitization so as to maintain their capital and risk-taking profile. In contrast, when banks’ income sources are squeezed (due to decreased lending, asset sales, and securitization), the observed increase in off-balance sheet trading activities seems to be motivated by income rather than hedging. Of key concern to regulators, we find no evidence that banks’ involvement in trading activities has changed the transmission of exogenous shocks through the capital and lending channels; banks still prioritize their balance sheet adjustments first through their traditional business activities and then through their trading activities.
Keywords: Asset selling; commercial banks; information risk; monetary policy; off-balance sheet trading activities; securitization; trading channel
JEL Classification: G01, G14, G21, G28
Suggested Citation: Suggested Citation