Quantitative Easing and Bank Risk Taking: Evidence from Lending

52 Pages Posted: 2 Nov 2015 Last revised: 11 Jan 2018

John Kandrac

Board of Governors of the Federal Reserve System

Bernd Schlusche

Board of Governors of the Federal Reserve System

Date Written: September 25, 2017

Abstract

A defining property of quantitative easing (QE) is the expansion of the monetary base through the creation of bank deposits -- or reserves -- by the central bank. In this paper, we assess the effect of this QE-induced reserve accumulation on bank-level lending and risk-taking activity. However, although banks must hold all reserves created by QE in aggregate, the observed distribution of reserves across banks is an outcome of private transactions. To overcome the inherent endogeneity of individual banks' reserve balances, we exploit instruments made available by a regulatory change that strongly influenced the distribution of newly-created reserves in the banking system. Our results show that bank reserves created by the Federal Reserve in two distinct QE programs led to higher total loan growth. Furthermore, we find that higher reserve balances induced increased risk taking within banks' loan portfolios, as indicated by both ex-ante and ex-post measures of risk-taking. These findings are consistent with theories of the portfolio substitution channel in which the transmission of QE depends in part on reserve creation itself.

Keywords: QE, bank lending, reserve balances, monetary policy, Federal Reserve, risk-taking channel, LSAP, portfolio substitution effect

JEL Classification: G21, E52, E58, G28

Suggested Citation

Kandrac, John and Schlusche, Bernd, Quantitative Easing and Bank Risk Taking: Evidence from Lending (September 25, 2017). Available at SSRN: https://ssrn.com/abstract=2684548 or http://dx.doi.org/10.2139/ssrn.2684548

John Kandrac (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Bernd Schlusche

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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