The Impact of Banks’ Interest Rate Risk on Monetary Policy Transmission

Combining bank-firm level credit registry data on the universe of loans and firms’ financial statements, we analyze the transmission of policy rate movements to banks’ lending behavior through their ex-ante exposure to interest rate risk. Controlling for demand side factors and other bank characteristics that are known to affect monetary policy transmission, our bank-firm level analyses show that banks with higher ex-ante exposure to interest rate risk reduce their lending and shorten their loan maturities once interest rates begin to rise, compare to banks with lower exposure. However, the effect is valid only for private banks, not state-owned banks. This effect is particularly pronounced for banks with low capital ratios, highlighting the importance of bank capital in contractionary periods. The effect persists at the firm level where firms are unable to avoid reductions in their loans by switching to less-exposed banks. Yet, this is the case only for SMEs, not for large firms. This reveals the asymmetric deterioration in SMEs’ lending conditions relative to large firms. We also document the real effects of the monetary policy transmission on firms’ sales and employment. Our findings reveal that SMEs, but not large firms, with higher exposure to interest rate risk through their banks experience declines in sales and employment.