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Monetary tightening, financial stability and the role of macroprudential policy

Author

Listed:
  • Luis Herrera

    (Banco de España)

  • Caterina Mendicino

    (European Central Bank)

  • Kalin Nikolov

    (European Central Bank)

  • Valerio Scalone

    (European Central Bank)

Abstract

This paper studies the financial stability risks and distributional effects of monetary policy tightening and the role of macroprudential policy in shaping these outcomes. We develop a macro-banking model with leveraged borrowers, banks subject to balance-sheet constraints and endogenous default. Higher policy rates increase borrower default risk and generate bank losses, amplifying the contraction in credit and disproportionately affecting financially constrained households. Structural macroprudential policies, including higher capital requirements and tighter loan-to-value caps, attenuate these effects by reducing leverage ex ante. The impact of countercyclical interventions is state-dependent: borrower-based measures mitigate the contraction in credit faced by constrained households, while releasing capital buffers supports lending when banks are well capitalized but can amplify credit contraction when balance sheets are weak.

Suggested Citation

  • Luis Herrera & Caterina Mendicino & Kalin Nikolov & Valerio Scalone, 2026. "Monetary tightening, financial stability and the role of macroprudential policy," Working Papers 2623, Banco de España.
    • Handle: RePEc:bde:wpaper:2623
    DOI: https://doi.org/10.53479/44147
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    Keywords

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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