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Title: Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy

Author(s): Augustin Landier, David Sraer and David Thesmar

Publication Date: December 2014

Keyword(s): bank lending, interest rate risk and monetary policy

Programme Area(s): Financial Economics

Abstract: We show that banks' cash flow exposure to interest rate risk, or income gap, plays a crucial role in their lending behavior following monetary policy shocks. In a first step, we show that the sensitivity of bank profits to interest rates increases significantly with their income gap, even when banks use interest rate derivatives. In a second step, we show that the income gap also predicts the sensitivity of bank lending to interest rates, both for commercial & industrial loans and for mortgages. Quantitatively, a 100 basis point increase in the Fed funds rate leads a bank at the 75th percentile of the income gap distribution to increase lending by about 1.6 percentage points annually relative to a bank at the 25th percentile. We conclude that banks' exposure to interest rate risk is an important determinant of the bank-level intensity of the lending channel.

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Bibliographic Reference

Landier, A, Sraer, D and Thesmar, D. 2014. 'Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10300