This paper examines the role of bank lending in the transmission of monetary policy in the presence of capital adequacy regulations. I develop a dynamic model of bank asset and liability management that incorporates risk-based capital requirements and an imperfect market for bank equity. These conditions imply a failure of the Modigliani-Miller theorem for the bank: its lending will depend on the bankâ€™s financial structure, as well as on lending opportunities and market interest rates. Combined with a maturity mismatch on the bankâ€™s balance sheet, this gives rise to a â€˜bank capital channelâ€™ by which monetary policy affects bank lending through its impact on bank equity capital. This mechanism does not rely on any particular role of bank reserves and thus falls outside the conventional â€˜bank lending channelâ€™. I analyze the dynamics of the new channel. An important result is that monetary policy effects on bank lending depend on the capital adequacy of the banking sector; lending by banks with low capital has a delayed and then amplified reaction to interest rate shocks, relative to well-capitalized banks. Other implications are that bank capital affects lending even when the regulatory constraint is not momentarily binding, and that shocks to bank profits, such as loan defaults, can have a persistent impact on lending
Monetary Policy, Bank Capital, Capital Requirements, Bank Lending Channel
In order to set up a list of libraries that you have access to,
you must first login
or sign up.
Then set up a personal list of libraries from your profile page by
clicking on your user name at the top right of any screen.