Monetary Policy, Leverage, and Bank Risk Taking

Author/Editor:

Giovanni Dell'Ariccia ; Robert Marquez ; Luc Laeven

Publication Date:

December 1, 2010

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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.

Series:

Working Paper No. 10/276

Subject:

Frequency:

Monthly

English

Publication Date:

December 1, 2010

ISBN/ISSN:

9781455210831/1018-5941

Stock No:

WPIEA2010276

Format:

Paper

Pages:

36

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