Why are Banks Exposed to Monetary Policy?
We propose a model of banks’ exposure to movements in interest rates and their role in the transmission of monetary shocks. Since bank deposits provide liquidity, higher interest rates allow banks to earn larger spreads on deposits. Therefore, if risk aversion is higher than one, banks' optimal dynamic hedging strategy is to take losses when interest rates rise. This risk exposure can be achieved by a traditional maturity-mismatched balance sheet, and amplifies the effects of monetary shocks on the cost of liquidity. The model can match the level, time pattern, and cross-sectional pattern of banks’ maturity mismatch.
We thank our discussants Nobu Kiyotaki, Skander Van den Heuvel, and Hervé Roche, as well as Jonathan Berk, V.V. Chari, Valentin Haddad, Arvind Krishnamurthy, Ben Hébert, Ben Moll, and Ed Nosal, for helpful comments, and Itamar Dreschler, Alexei Savov, Philipp Schnabl, William English, Skander Van den Heuvel and Egon Zakrajsek for sharing their data with us. Ricardo de la O Flores provided exceptional research assistance. This paper previously circulated under the title “Monetary Shocks and Bank Balance Sheets”. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.