Monetary Policy and Bank Risk-Taking

Abstract

This paper contributes to the debate by showing that the relationship between the monetary policy stance and bank risk taking is more complex than generally believed. Most of the debate so far has focused on how monetary policy easing can induce greater risk taking through a search for yield or its effects on leverage and asset prices, a view this paper broadly supports. But, at least in the short run, there is also an opposite risk-shifting effect when financial intermediaries operate with limited liability. The balance, then, depends on financial intermediaries’ degree of limited liability and financial health. When the policy rate is low, high-charter-value (well-capitalized) banks increase risk taking; low-charter-value (poorly capitalized) banks do the opposite.