CEPR Discussion Paper – Banks’ Systemic Risk and Monetary Policy

Ester Faia, and Soeren Karau
January 2019

The risk-taking channel of monetary policy acquires relevance only if it affects systemic risk. We find robust evidence of a systemic risk-taking channel using cross-country and time-series evidence in panel and proxy VARs for 29 G-SIBs from seven countries. We detect a significant role for pecuniary externalities by exploiting the differential impact of monetary policy shocks on book and market leverage. We rationalize these findings through a model in which a fall in interest rates induces banks to increase leverage and reduce monitoring. In an interacted VAR, we find that macro-prudential policy has a significant role in taming the unintended consequences of monetary policy on systemic risk.

Banks’ Systemic Risk and Monetary Policy