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The impact of monetary policy shocks on banks' systemic risk in canada

Author

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  • H. Semih Yildirim

    (York University)

  • Mortaza Baky Haskuee

    (University of Toronto)

Abstract

This paper analyzes the impact of monetary policy shocks on systemic risk within Canada’s concentrated banking sector, where a few large institutions hold significant market influence. Utilizing Structural Vector Autoregression (SVAR) and Panel Vector Autoregression (PVAR) models, we evaluate how changes in key monetary policy variables, specifically policy rate adjustments and fluctuations in money supply, affect various systemic risk indicators, including Marginal Expected Shortfall (MES), Long-Run Marginal Expected Shortfall (LRMES), and Conditional Value at Risk (CoVaR). The results reveal that expansionary monetary policy, particularly through increased money supply, temporarily heightens systemic risk as banks leverage added liquidity. This risk-taking behavior aligns with the short-term rise in MES and LRMES, emphasizing how liquidity injections can elevate financial vulnerabilities. Conversely, contractionary monetary policies, such as rate hikes, reduce risk measures like MES and LRMES by encouraging more conservative lending practices, as the higher borrowing costs deter excessive risk-taking. However, contractionary policies may increase credit-related systemic risk, as reflected in metrics like ΔCoVaR, potentially due to increased debt servicing pressures. The results highlight the importance of carefully calibrated monetary policy, to balance economic growth objectives with the imperative of financial stability especially within concentrated banking environments, where institutional interconnectedness amplifies risk propagation.

Suggested Citation

  • H. Semih Yildirim & Mortaza Baky Haskuee, 2025. "The impact of monetary policy shocks on banks' systemic risk in canada," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 49(1), pages 141-175, March.
    • Handle: RePEc:spr:jecfin:v:49:y:2025:i:1:d:10.1007_s12197-024-09700-y
    DOI: 10.1007/s12197-024-09700-y
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    More about this item

    Keywords

    Monetary policy; Bank systemic risk; Structural VAR (SVAR); Canadian banking;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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