Bank Leverage and Monetary Policy's Risk-Taking Channel: Evidence from the United States

We present evidence of a risk-taking channel of monetary policy for the U.S. bankingsystem. We use confidential data on the internal ratings of U.S. banks on loans tobusinesses over the period 1997 to 2011 from the Federal Reserve's survey of terms ofbusiness lending. We find that ex-ante risk taking by banks (as measured by the risk ratingof the bank's loan portfolio) is negatively associated with increases in short-term policyinterest rates. This relationship is less pronounced for banks with relatively low capital orduring periods when banks' capital erodes, such as episodes of financial and economicdistress. These results contribute to the ongoing debate on the role of monetary policy infinancial stability and suggest that monetary policy has a bearing on the riskiness of banksand financial stability more generally.