Monetary Policy, Bank Leverage, and Financial Stability

WPIEA2011244 Image
Price:  $18.00

Author/Editor: Fabian Valencia
Release Date: © October, 2011
ISBN : 978-1-46392-323-5
Stock #: WPIEA2011244
English
Stock Status: On back-order

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Description

This paper develops a model to assess how monetary policy rates affect bank risk-taking. In the model, a reduction in the risk-free rate increases lending profitability by reducing funding costs and increasing the surplus the monopolistic bank extracts from borrowers. Under limited liability, this increased profitability affects only upside returns, inducing the bank to take excessive leverage and hence risk. Excessive risk-taking increases as the interest rate decreases. At a broader level, the model illustrates how a benign macroeconomic environment can lead to excessive risk-taking, and thus it highlights a role for macroprudential regulation.

Taxonomy

Economic policy , Monetary policy




More publications in this series: Working Papers


More publications by: Fabian Valencia