Working Paper: CEPR ID: DP8199
Authors: Giovanni Dell'Ariccia; Luc Laeven; Robert Marquez
Abstract: The recent global financial crisis has ignited a debate on whether easy monetary conditions can lead to greater bank risk-taking. We study this issue in a model of leveraged financial intermediaries that endogenously choose the riskiness of their portfolios. When banks can adjust their capital structures, monetary easing unequivocally leads to greater leverage and higher risk. However, if the capital structure is fixed, the effect depends on the degree of leverage: following a policy rate cut, well capitalized banks increase risk, while highly levered banks decrease it. Further, the capitalization cutoff depends on the degree of bank competition. It is therefore expected to vary across countries and over time.
Keywords: banking; leverage; monetary policy; risk taking
JEL Codes: E44; E58; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | Risk depends on leverage (G32) |
| Well-capitalized banks (G28) | Decrease monitoring (E63) |
| Highly leveraged banks (G21) | Increase monitoring (E63) |
| Interest rate passthrough, risk shifting, leverage (G21) | Impact of monetary policy on bank risk-taking (E52) |
| Monetary easing (E52) | Greater leverage (G19) |
| Greater leverage (G19) | Higher risk (D81) |
| Monetary easing (E52) | Higher risk (D81) |
| Policy rate cut (E52) | Greater risk-taking (D81) |