Hazardous times for monetary policy : What do twenty-three million bank loans say about the effects of monetary policy on credit risk-taking?

TLDR: In this paper, the authors identify the effects of monetary policy on credit risk-taking with an exhaustive credit register of loan applications and contracts, and find that a lower overnight interest rate induces lowly capitalized banks to grant more loan applications to ex ante risky firms and to commit larger loan volumes with fewer collateral requirements to these firms, yet with a higher ex post likelihood of default.

Abstract: We identify the effects of monetary policy on credit risk-taking with an exhaustive credit register of loan applications and contracts. We separate the changes in the composition of the supply of credit from the concurrent changes in the volume of supply and quality, and the volume of demand. We employ a two-stage model that analyzes the granting of loan applications in the first stage and loan outcomes for the applications granted in the second stage, and that controls for both observed and unobserved, time-varying, firm and bank heterogeneity through time*firm and time*bank fixed effects. We find that a lower overnight interest rate induces lowly capitalized banks to grant more loan applications to ex ante risky firms and to commit larger loan volumes with fewer collateral requirements to these firms, yet with a higher ex post likelihood of default. A lower long-term interest rate and other relevant macroeconomic variables have no such effects.

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FIGURE 1.—The probability a loan application is granted (left-hand scale) by a bank with low versus high capital (by median) to an otherwise average firm with non-performing loans outstanding in the previous 4 years (HR) versus a firm without (LR), and the change in the overnight interest rate (right-hand scale).

TABLE I SUMMARY STATISTICS OF ALL VARIABLES USED IN THE ESTIMATIONS ON THE SAMPLE SELECTION MODEL USING LOAN APPLICATIONSa

FIGURE 2.—The logarithm of the committed amount of granted loans (left-hand scale) by a bank with low versus high capital (by median) to an otherwise average firm with non-performing loans outstanding in the previous 4 years (HR) versus a firm without (LR), and the change in the overnight interest rate (right-hand scale).