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Monetary policy and risk taking

  • Angeloni, Ignazio
  • Faia, Ester
  • Lo Duca, Marco

We assess the effects of monetary policy on bank risk to verify the existence of a risk-taking channel - monetary expansions inducing banks to assume more risk. We first present VAR evidence confirming that this channel exists and tends to concentrate on the bank funding side. Then, to rationalize this evidence we build a macro model where banks subject to runs endogenously choose their funding structure (deposits vs. capital) and risk level. A monetary expansion increases bank leverage and risk. In turn, higher bank risk in steady state increases asset price volatility and reduces equilibrium output.

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Paper provided by Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt in its series SAFE Working Paper Series with number 8.

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Date of creation: 2013
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Handle: RePEc:zbw:safewp:8
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  1. Bae, Jinho & Kim, Chang-Jin & Nelson, Charles R., 2007. "Why are stock returns and volatility negatively correlated?," Journal of Empirical Finance, Elsevier, vol. 14(1), pages 41-58, January.
  2. Ana Fostel & John Geanakoplos, 2010. "Why Does Bad News Increase Volatility and Decrease Leverage?," Cowles Foundation Discussion Papers 1762RR, Cowles Foundation for Research in Economics, Yale University, revised Aug 2011.
  3. Goodhart, Charles & Schoenmaker, Dirk, 1995. "Should the Functions of Monetary Policy and Banking Supervision Be Separated?," Oxford Economic Papers, Oxford University Press, vol. 47(4), pages 539-60, October.
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  8. Douglas W. Diamond & Raghuram G. Rajan, 1999. "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," NBER Working Papers 7430, National Bureau of Economic Research, Inc.
  9. Faia, Ester & Monacelli, Tommaso, 2007. "Optimal interest rate rules, asset prices, and credit frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3228-3254, October.
  10. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York.
  11. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, 05.
  12. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
  13. Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 0698, European Central Bank.
  14. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  15. Alessi, Lucia & Detken, Carsten, 2009. "'Real time'early warning indicators for costly asset price boom/bust cycles: a role for global liquidity," Working Paper Series 1039, European Central Bank.
  16. Raghuram G. Rajan, 2005. "Has Financial Development Made the World Riskier?," NBER Working Papers 11728, National Bureau of Economic Research, Inc.
  17. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  18. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
  19. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
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