Monetary policy and bank risk-taking

Zhang, Zheng (2019) Monetary policy and bank risk-taking. Doctoral thesis, University of East Anglia.

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Taking risk is an integral part of the banking business, they had to try managing risk since the emergence of the bank industry. In the wave of the recent global financial crisis, when researchers and policymakers start to study its causes, the topic of the effect of monetary policy on bank’s risk-taking incentives has been brought to the forefront of the economic policy debate, because it has been widely agreed that monetary policy contributes to the recent financial crisis build-up, via the excessive risk taking in financial sectors. Hence, this thesis is broadly related to the relationship between monetary policy and the bank’s risk-taking. It explains in detail the different effects of conventional and unconventional monetary policy on bank risk-taking behavior in different periods.

The second chapter identifies the impact of the monetary policy on the behaviour of banks risk taking in theoretical foundation with different assumptions in different market structures. In our model, monetary policy may affect banks’ perceptions of risk taking, and their attitude to risk taking in three forces: the values effect, the search for yield effect, and the risk taking channel effect. We analyse several cases in which with different market structures, a reasonable bank monitoring cost functions and different loan demand functions exist. By letting banks maximize their profits and achieve the equilibrium, we have different theoretical results of our models, with the assumption of unlimited liability for the bank, and with the assumption of limited liability for the bank in the case of failure. We combine the convex monitoring cost function with a linear loan demand function, a concave loan demand function, and a piecewise loan demand function, and achieve three different results under each assumption. And finally, we have six propositions about the effect of monetary policy on bank risk taking. In most cases, the results indicate the low interest rate will spur bank risk taking.

Chapter 3 investigates the relationship between short-term low interest rates and bank risk-taking in the U.S. banking system, by using a unique quarterly dataset that includes balance sheet information for listed top 30 banks in the U.S. over the period from 2000 to 2017. In this chapter, we apply a Generalised Method of Moments (GMM) to address the dynamic effect. We find evidence that low interest rates will contribute to the increase of bank risk-taking. Moreover, this effect of monetary policy on bank risk-taking is stronger after the financial crisis, and weaker before the financial crisis. We also discuss the different effects of short term interest rates on risk-taking by banks with different characteristics, such as, the capacity of the bank’s capitalization, and bank’s equity ratio. The result indicates that the effect of short-term interest rates on bank risk-taking is less pronounced for poorly capitalized banks; the effect of short-term interest rates on bank risk-taking is also stronger for the banks financed with a higher portion of equity. Finally, season will change bank risk taking behavior as well, and power is especially strong at the period of pre-crisis.

In chapter 4, by using U.S. individual bank’s balance sheet data, we analyze whether and how the Federal Reserve’s LSAPs, referred to as QE, affected bank lending standards, and especially the bank risk-taking behavior. The results indicate that all three waves of quantitative easing, QE1, QE2,and QE3 had significant effects on lowing bank lending standards, which means, because of QE, it leads banks to issue relatively more risky loans with lower lending standards. We also compare the effect between the unconventional monetary policy instrument, QE, and the conventional monetary policy instrument, short-term interest rate, in the model. The results show that because the United States’ short term interest rate has been lowered to zero lower bound, although it still has an effect on the bank risk taking behavior, but it will keep relatively constant. And in this case, we can carefully say that quantitative easing is a more effective tool to stimulate the economy by replacing the role of monetary policy rate during this period.

Item Type: Thesis (Doctoral)
Faculty \ School: Faculty of Social Sciences > School of Economics
Depositing User: Chris White
Date Deposited: 24 Nov 2020 14:56
Last Modified: 24 Nov 2020 14:56

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