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Monetary Policy, Bank Leverage, and Financial Stability

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  • Fabian Valencia

Abstract

This paper develops a model to assess how monetary policy rates affect bank risk-taking. In the model, a reduction in the risk-free rate increases lending profitability by reducing funding costs and increasing the surplus the monopolistic bank extracts from borrowers. Under limited liability, this increased profitability affects only upside returns, inducing the bank to take excessive leverage and hence risk. Excessive risk-taking increases as the interest rate decreases. At a broader level, the model illustrates how a benign macroeconomic environment can lead to excessive risk-taking, and thus it highlights a role for macroprudential regulation.

Suggested Citation

  • Fabian Valencia, 2011. "Monetary Policy, Bank Leverage, and Financial Stability," IMF Working Papers 11/244, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:11/244
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    Cited by:

    1. Agur, Itai & Demertzis, Maria, 2013. "“Leaning against the wind” and the timing of monetary policy," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 179-194.
    2. Angela Maddalonia & Jose-Luis Peydro, 2013. "Monetary Policy, macroprudential Policy, and Banking Stability: Evidence from the Euro Area," International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 121-169, March.
    3. Langedijk, Sven & Nicodème, Gaëtan & Pagano, Andrea & Rossi, Alessandro, 2015. "Debt Bias in Corporate Income Taxation and the Costs of Banking Crises," CEPR Discussion Papers 10616, C.E.P.R. Discussion Papers.
    4. Delis, Manthos D & Hasan, Iftekhar & Mylonidis, Nikolaos, 2011. "The risk-taking channel of monetary policy in the USA: Evidence from micro-level data," MPRA Paper 34084, University Library of Munich, Germany.
    5. Delis, Manthos D. & Karavias, Yiannis, 2015. "Optimal versus realized bank credit risk and monetary policy," Journal of Financial Stability, Elsevier, vol. 16(C), pages 13-30.
    6. Manthos D. Delis & Iftekhar Hasan & Nikolaos Mylonidis, 2017. "The Risk‐Taking Channel of Monetary Policy in the U.S.: Evidence from Corporate Loan Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(1), pages 187-213, February.
    7. repec:eee:ememar:v:31:y:2017:i:c:p:116-140 is not listed on IDEAS
    8. Malgorzata Olszak & Mateusz Pipien & Iwona Kowalska & Sylwia Roszkowska, 2015. "The impact of capital on lending in publicly-traded and privately- held banks in the EU," Faculty of Management Working Paper Series 72015, University of Warsaw, Faculty of Management.
    9. Itai Agur & Maria Demertzis, 2015. "Will Macroprudential Policy Counteract Monetary Policy’s Effects on Financial Stability?," IMF Working Papers 15/283, International Monetary Fund.
    10. Gilbert COLLETAZ & Grégory LEVIEUGE & Alexandra POPESCU, 2016. "Monetary Policy and Long-Run Risk-Taking," LEO Working Papers / DR LEO 2409, Orleans Economics Laboratory / Laboratoire d'Economie d'Orleans (LEO), University of Orleans.
    11. Ekin Ayse Ozsuca & Elif Akbostanci, 2012. "An Empirical Analysis of the Risk Taking Channel of Monetary Policy in Turkey," ERC Working Papers 1208, ERC - Economic Research Center, Middle East Technical University, revised Dec 2012.
    12. Agur, Itai & Demertzis, Maria, 2012. "Excessive bank risk taking and monetary policy," Working Paper Series 1457, European Central Bank.
    13. Chen, Minghua & Wu, Ji & Jeon, Bang Nam & Wang, Rui, 2017. "Monetary policy and bank risk-taking: Evidence from emerging economies," Emerging Markets Review, Elsevier, pages 116-140.
    14. Renata Karkowska, 2015. "The role of investment banking in systemic risk profiles. Evidence from a panel of EU banking sectors," Faculty of Management Working Paper Series 22015, University of Warsaw, Faculty of Management.
    15. Yuri Biondi & Feng Zhou, 2017. "Interbank Credit and the Money Manufacturing Process. A Systemic Perspective on Financial Stability," Papers 1702.08774, arXiv.org.

    More about this item

    Keywords

    Financial stability; Monetary policy; Bank Leverage; Macroprudential regulation; bank capital; capital requirements; risk of default; bank default; bank risk; Financial Markets and the Macroeconomy;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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