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Monetary Policy, Leverage, and Bank Risk-Taking

  • Giovanni Dell'Ariccia
  • Robert Marquez
  • Luc Laeven

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.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/276.

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Length: 36
Date of creation: 01 Dec 2010
Date of revision:
Handle: RePEc:imf:imfwpa:10/276
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  1. Mitchell Berlin & Loretta J. Mester, 1997. "Deposits and relationship lending," Working Papers 96-18, Federal Reserve Bank of Philadelphia.
  2. Mark T. Leary & Michael R. Roberts, 2005. "Do Firms Rebalance Their Capital Structures?," Journal of Finance, American Finance Association, vol. 60(6), pages 2575-2619, December.
  3. Maddaloni, Angela & Peydró, José-Luis, 2010. "Bank risk-taking, securitization, supervision and low interest rates: Evidence from the euro area and the U.S. lending standards," Working Paper Series 1248, European Central Bank.
  4. repec:dgr:kubcen:201035s is not listed on IDEAS
  5. Douglas W. Diamond & Raghuram G. Rajan, 2009. "Illiquidity and Interest Rate Policy," NBER Working Papers 15197, National Bureau of Economic Research, Inc.
  6. Gabriella Chiesa, . "Incentive-based Lending Capacity, Competition and Regulation in Banking," Working Papers 92, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  7. repec:dgr:kubcen:200931s is not listed on IDEAS
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