Why are Banks Exposed to Monetary Policy?

Abstract

We propose a model of banks' exposure to movements in interest rates and their role in the transmission of monetary shocks. Since bank deposits provide liquidity, higher interest rates allow banks to earn larger spreads on deposits. Therefore, if risk aversion is higher than one, banks' optimal dynamic hedging strategy is to take losses when interest rates rise. This risk exposure can be achieved by a traditional maturity-mismatched balance sheet, and amplifies the effects of monetary shocks on the cost of liquidity. The model can match the level, time pattern, and cross-sectional pattern of banks' maturity mismatch.

Banking on Deposits: Maturity Transformation Without Interest Rate Risk

“…In a recent class of dynamic general equilibrium models, maturity transformation in the financial sector varies with the magnitude of the term premium and effective risk aversion (He and Krishnamurthy 2013, Brunnermeier and Sannikov 2014, 2016, Drechsler, Savov, and Schnabl 2018. In Di Tella and Kurlat (2017), as in our paper, deposit rates are relatively insensitive to interest rate changes (due to a net worth constraint rather than market power).…”

Banks, Maturity Transformation, and Monetary Policy

“…1 Hoffmann, Langfield, Pierobon and Vuillemey (2019) use data for several Euro area countries and find that banks' exposure to interest rate risk is heterogeneous in the cross-section. Apart from these empirical contributions, Di Tella and Kurlat (2017) build a model in which banks' maturity mismatch and exposure to interest rate risk emerges as an equilibrium outcome. Their model predicts bank equity responses to interest rate shocks in the range of the numbers that I obtain.…”

Bank Coordination and Monetary Transmission: Evidence from India

“…1 The first is the bank reserves channel, which focuses on the role of reserves in determining the volume of demand deposits and, thus, bank lending (Bernanke and Blinder, 1988;Kashyap and Stein, 1995). The second is the bank capital channel in which an increase in nominal interest rates can adversely affect maturity-mismatched bank balance sheets featuring long-duration nominal assets and short-duration nominal liabilities (Van den Heuvel et al, 2002;Bolton and Freixas, 2000;Brunnermeier and Sannikov, 2016;Di Tella and Kurlat, 2017). The third is the market power channel in which policy rate changes incentivize banks to change markups on deposits, thereby affecting loanable funds (Scharfstein and Sunderam, 2016;Drechsler et al, 2017).…”