Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy

Abstract

We show empirically that banks' exposure to interest rate risk, or income gap, plays a crucial role in monetary policy transmission. In a first step, we show that banks typically retain a large exposure to interest rates that can be predicted with income gap. Secondly, we show that income gap also predicts the sensitivity of bank lending to interest rates. Quantitatively, a 100 basis point increase in the Fed funds rate leads a bank at the 75th percentile of the income gap distribution to increase lending by about 1.6 percentage points annually relative to a bank at the 25th percentile.

Reference

Augustin Landier, David Sraer, and David Thesmar, “Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy”, IDEI Working Paper, n. 800, February 2013.