Bank Risks, Risk Preferences and Lending - May 2005

The recent debate on the impact of capital regulation on bank behaviour shows that risk exposures of banks might in‡uence the amount of loans newly granted to the non-…nancial sector. The paper analyses implications of this relationship for the role of …nancial stability analysis in the conduct of monetary policy. This role stems from the fact that the …nancial instability can in‡uence the monetary transmission mechanism. After a monetary policy shock the market price of risk and loan loss distribution change. The credit spreads for loans already granted might then be not enough to cover expected losses and the default probability of a bank increases. If the bank intends to maintain the previous level of the probability of default, either additional capital or a change in the asset structure is needed. This constitutes an additional way in which monetary policy might in‡uence the supply of bank loans. The implications of the presented model are tested using the data for the Polish banking sector during the period 1997-2004. Assuming homogeneity of borrowers across banks it is shown that variables proxying bank risk preferences and the level of risk undertaken (also when interacted with a monetary policy measure) are signi…cant in regressions explaining changes in the amount of bank loan supply. National Bank of Poland, Financial System Department and Warsaw School of Economics, Chair of Monetary Policy ([email protected]). A part of the research presented in the paper was conducted during my visit at the European Central Bank, Directorate General Research. I would like to thank M. Brzoza-Brzezina, M. Ehrmann, A. G÷ogowski, P. Hartmann, M. Kolasa, K.-G. Lindquist, T. Opiela, D. Serwa and Z. Polański for very useful discussions, comments and suggestions at the di¤erent stages of the project. All errors and omissions remain my own. The paper presents only my views and opinions and not necessarily those of the institutions I am a¢ liated with.