Monetary Policy, Bank Leverage, and Financial Stability

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.
Publication date: October 2011
ISBN: 9781463923235
$18.00
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Topics covered in this book

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Economics- Macroeconomics , Economics / General , International - Economics , bank capital , capital requirements , risk of default , bank default , bank risk , bankrupt , probability of default , recapitalization , risk aversion , bank risk-taking , bank profits , banking , bank contracts , bank defaults , risk taking , banking sector , monetary authority , state

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