DP8199 Monetary Policy, Leverage, and Bank Risk-taking

Author(s): Giovanni DellAriccia, Luc Laeven, Robert Marquez
Publication Date: January 2011
Keyword(s): banking, leverage, monetary policy, risk taking
JEL(s): E44, E58, G21
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8199

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.