© 2011 International Monetary Fund WP/
IMF Working Paper
Monetary Policy, Bank Leverage, and Financial StabilityPrepared by Fabian Valencia
Authorized for distribution by Stijn ClaessensOctober 2011
This paper develops a model to assess how monetary policy rates affect bank risk-taking.n the model, a reduction in the risk-free rate increases lending profitability by reducingfunding costs and increasing the surplus the monopolistic bank extracts from borrowers.nder limited liability, this increased profitability affects only upside returns, inducing theank to take excessive leverage and hence risk. Excessive risk-taking increases as theinterest rate decreases. At a broader level, the model illustrates how a benignacroeconomic environment can lead to excessive risk-taking, and thus it highlights aole for macroprudential regulation.JEL Classification Numbers:C61, E32, E44Keywords: Financial Stability, Bank Leverage, Monetary Policy, Macroprudential regulationAuthor’s E-Mail Address:firstname.lastname@example.org
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarilyrepresent those of the IMF or IMF policy. Working Papers describe research in progress by theauthor(s) and are published to elicit comments and to further debate.
I am grateful to Larry Ball, Christopher Carroll, Stijn Claessens, Manthos Delis, Giovanni Dell'Ariccia, LucLaeven, and Damiano Sandri for comments and discussions.