5 The risk-taking channel
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1 5 The risk-taking channel Adrian, Tobias and Hyun Song Shin (2010), The changing nature of financial intermediation and the financial crisis of , Annual Review of Economics, (also available as Fed New York, Staff report no. 439). Borio, Claudio and Haibin Zhu (2012), Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?, Journal of Financial Stability 8, Bruno, Valentina and Shin, Hyun Song (2013), Capital flows and the risk-taking channel of monetary policy, NBER, Working paper No Woodford, Michael (2010), Financial Intermediation and Macroeconomic Analysis, Journal of Economic Perspectives 24, Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Why a risk-taking channel? We have seen that increasing interest rates: drive the less risky borrowers out of the market increase the incentive to invest in the more risky project increase agency costs These conclusions are drawn under the assumptions that for lenders (banks) the ability to take risk remains unchanged the attitude towards risk remains unchanged The risk-taking channel deals with: time-varying, endogenous risk-taking by banks/investors endogenous risk assessment (of the same portfolio) Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS18 5 2
2 Channels for endogenous risk-taking: interest rate changes lead to time-varying risk-pricing (risk premium): default of banks (so far not considered in theory), possibly due to default of borrowers, impacts heavily on the financial system spread between market rate and target rate of return: search for yield (on the side of banks/investors) particularly present during low interest rate periods insurance effect of central banks transparent communication and commitment as lender of last resort: removing future uncertainty and censoring future negative outcomes leads to asymmetric risk-taking behaviour in the financial system Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Institutional changes that affect the strength of the risk-taking channel: Financial liberalization led to securitisation and increased possibilities of obtaining external finance: Deepening of financial markets increased interbank market liquidity (Adrian and Shin, 2010) Basle III with higher capital requirements, counter-cyclical buffers might dampen the effect Fair value accounting practice is highly sensitive to risk premia Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS18 5 4
3 5.2 Elements to describe the risk-taking channel The risk-taking channel is intertwined with the credit channel, but new elements provide the distinguishing characteristics: Changing risk perception Woodford, 2010: Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Senior Loan Officer Opinion Survey: Net Percent of Domestic Respondents Tightening Standards for Commercial and Industrial Loans Loans to large and middle-market firms Loans to small firms Oct. survey Net percent Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS18 5 6
4 Intermediation/liquidity (Adrian and Shin, 2010) Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Endogenous leverage: Total Assets/Equity (Adrian and Shin, 2010, and Bruno and Shin, 2013) Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS18 5 8
5 To illustrate endogenous leverage: Assume a value at risk constraint: A(ssets) k(1 + i s )D(ebt) Assume assets payoff: s(1 + i b )A VaR is satisfied when: D/A s k (1 + ib )/(1 + i s ) Leverage is increasing in the spread. Debt is positively related to asset prices. (Adrian and Shin, 2010) Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Intermediation and interest rate spreads Based on Woodford (2010) Frictionless credit markets (single interest rate): Monetary expansion: Transitory increase in income increases savings Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS
6 Intermediated credit markets with multiple interest rates: Demand is determined by the premium that borrowers are willing to pay over the interest rate needed to induce savers to fund the intermediate. Mainly income shifts displace the XD schedule (demand for intermediation). Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Determinants of intermediation supply : increasing marginal costs of lending limited capital of intermediaries or of natural buyers of the borrowers debt leverage constraints imposed by regulatory capital requirements or by the intermediary s creditors value of available collateral for additional funding render leverage endogenous and positively related to the spread any shock that affects intermediaries capital shifts the XS schedule Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS
7 Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS Recent literature Macroeconomic models including a risk channel: Boz, Emine and Enrique G. Mendoza (2014), Financial innovation, the discovery of risk and the U.S. credit crisis, Journal of Monetary Economics 62, Brunnermeier, Markus and Yuliy Sannikov (2014), A macroeconomic model with a financial sector, American Economic Review 104, Christiano, Lawrence J. Roberto Motto and Massimo Rostagno (2014), Risk shocks, American Economic Review 104, Gorton, Gary and Guillermo Ordoñez (2014), Collateral crises, American Economic Review 104, Gust Christopher and David López-Salido (2014), Monetary policy and the cyclicality of risk, Journal of Monetary Economics 62, Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS
8 Papers dealing with lending standards: Bassett, William F. and Mary Beth Chosak and John C. Driscoll and Zakrajšek (2014), Changes in bank lending standards and the macroeconomy, Journal of Monetary Economics 62, Jiménez, Gabriel and Steven Ongena and José-Luis Peydró and Jesús Saurina (2014), Hazardous times for monetary policy: What do twenty-three million bank loans say about the effects of monetary policy on credit risk-taking?, Econometrica 82, Monetary Policy Transmission, Risk-taking channel, Sylvia Kaufmann, FS
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