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Monetary Policy Exposure of Banks and Loan Contracting

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Abstract

We provide evidence that banks use loan covenants to prepare for future monetary policy tightening, thereby facilitating the bank lending channel of monetary policy transmission. Specifically, banks with greater monetary policy exposure—those whose lending capacity contracts more as the federal funds rate increases—include stricter financial covenants in loan contracts, granting them flexibility to reduce existing loan commitments during monetary policy tightening when firms breach covenants. The resulting credit reductions to covenant violators by high-exposure banks account for over one-third of the total decline in credit during recent federal funds rate hikes.

Suggested Citation

  • Ahmet Degerli & Jing Wang, 2026. "Monetary Policy Exposure of Banks and Loan Contracting," Finance and Economics Discussion Series 2026-008, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:102441
    DOI: 10.17016/FEDS.2026.008
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    Keywords

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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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