Working Paper: NBER ID: w24076
Authors: Sebastian Di Tella; Pablo Kurlat
Abstract: We propose a model of banks’ exposure to movements in interest rates and their role in the transmission of monetary shocks. Since bank deposits provide liquidity, higher interest rates allow banks to earn larger spreads on deposits. Therefore, if risk aversion is higher than one, banks' optimal dynamic hedging strategy is to take losses when interest rates rise. This risk exposure can be achieved by a traditional maturity-mismatched balance sheet, and amplifies the effects of monetary shocks on the cost of liquidity. The model can match the level, time pattern, and cross-sectional pattern of banks’ maturity mismatch.
Keywords: banks; monetary policy; interest rates; liquidity; dynamic hedging
JEL Codes: E41; E43; E44; E51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Banks' exposure to monetary policy (E58) | Banks' balance sheets (G21) |
| Interest rate movements (E43) | Banks' balance sheets (G21) |
| Interest rates rise (E43) | Banks incur losses (G21) |
| Banks incur losses (G21) | Anticipated higher profits due to increased deposit spreads (G21) |
| Nominal interest rates increase (E43) | Opportunity cost of holding currency rises (F31) |
| Opportunity cost of holding currency rises (F31) | Increase in equilibrium spread between nominal interest rates and deposit rates (E43) |
| Nominal interest rates increase (E43) | 30% loss of banks' net worth (G21) |
| Banks' willingness to absorb short-term losses (G21) | Anticipated higher returns on equity (G12) |
| Higher deposit-to-net-worth ratios (G21) | Greater maturity mismatches (D15) |
| Interest rates (E43) | Deposit spreads (G21) |
| Weaker bank net worth (F65) | Deposit spreads (G21) |
| Interest rates (E43) | Amplification factor of 1.25 (C29) |