The Impact of Interest Rate Risk on Bank Lending

In this paper, we empirically analyze the transmission of realized interest rate risk – the gain or loss in bank economic capital due to movements in interest rates – to bank lending. We exploit a unique panel data set that contains supervisory information on the repricing maturity profiles of Swiss banks and provides us with an individual measure of interest rate risk exposure net of hedging. Our analysis yields three main results. First, our estimates indicate that a year after a permanent 1 percentage point upward shock in nominal interest rates, the average bank of 2013Q3 would ceteris paribus reduce its cumulative loan growth by approximately 170 basis points. An estimated 28% of this reduction would be the result of realized interest rate risk exposure weakening the bank’s economic capital. Second, due to the banks’ heterogeneity in interest rate risk exposure, the effect of the shock would differ across institutions and could be redistributive across regions. Finally, bank lending seems to be mainly driven by capital rather than liquidity, suggesting that a higher capitalized banking system can better shield its creditors from shocks in interest rates.