European Parliament Library

Monetary Policy, Bank Leverage, and Financial Stability, Fabian Valencia

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
Table Of Contents
Cover Page; Title Page; Copyright Page; Contents; I. Introduction; II. Loan and Deposit Contracts; A. Bank-Borrower Loan Contract; B. Bank-Depositor Contract; III. The Bank's One Period Problem; 1. Optimal Lending and Default Risk: The One Period Case; IV. The Infinite Horizon Case; A. Modeling the Bank as a Firm; 1. A Constrained Social Planner Benchmark; 2. Marginal Value of Bank Capital; B. Optimal Decision Rules; 3. Lending and Dividends Optimal Decision Rules; 1. Steady State Values; 4. Excessive Risk of Bank Default; C. Response to Interest Rate Shocks
Literary Form
non fiction
Description based upon print version of record
Physical Description
1 online resource (57 p.)
Specific Material Designation
Form Of Item

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