DP13456 Banks' Systemic Risk and Monetary Policy

Author(s): Ester Faia, Soeren Karau
Publication Date: January 2019
Keyword(s): DeltaCoVaR, leverage, LRMES, macroprudential policy, monitoring intensity, panel VAR, policy complementarities, proxy VAR, Risk-taking channel of monetary policy
JEL(s): E44, E52, G18, G21
Programme Areas: Financial Economics, International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13456

The risk-taking channel of monetary policy acquires relevance only if it affects systemic risk. We find robust evidence of a systemic risk-taking channel using cross-country and time-series evidence in panel and proxy VARs for 29 G-SIBs from seven countries. We detect a significant role for pecuniary externalities by exploiting the differential impact of monetary policy shocks on book and market leverage. We rationalize these findings through a model in which a fall in interest rates induces banks to increase leverage and reduce monitoring. In an interacted VAR, we find that macro-prudential policy has a significant role in taming the un-intended consequences of monetary policy on systemic risk.