DP10300 Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy

Author(s):	Augustin Landier, David Sraer, David Thesmar
Publication Date:	December 2014
Keyword(s):	bank lending, interest rate risk, monetary policy
JEL(s):	E44, E52, G21
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=10300

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.