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Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy

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  • Thesmar, David
  • Landier, Augustin
  • Sraer, David

Abstract

We show that banks' cash flow exposure to interest rate risk, or income gap, plays a crucial role in their lending behavior following monetary policy shocks. In a first step, we show that the sensitivity of bank profits to interest rates increases significantly with their income gap, even when banks use interest rate derivatives. In a second step, we show that the income gap also predicts the sensitivity of bank lending to interest rates, both for commercial & industrial loans and for mortgages. Quantitatively, a 100 basis point increase in the Fed funds rate leads a bank at the 75th percentile of the income gap distribution to increase lending by about 1.6 percentage points annually relative to a bank at the 25th percentile. We conclude that banks' exposure to interest rate risk is an important determinant of the bank-level intensity of the lending channel.

Suggested Citation

  • Thesmar, David & Landier, Augustin & Sraer, David, 2014. "Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy," CEPR Discussion Papers 10300, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:10300
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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
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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