A Trade-off Between Monetary Policy Transmission and Systemic Risk
We study how interbank funding links monetary policy transmission to systemic risk in a banking system with heterogeneous access to deposit funding. Using bank-level data from China, we show that monetary policy easing reallocates liquidity through the interbank market: large banks raise household demand deposits and lend in the interbank market, while small banks expand loans through interbank borrowing. During economic downturns, greater reliance on interbank funding is associated with higher systemic risk. To interpret these facts, we build a structural model with deposit-rich and deposit-poor banks and interbank rollover risk. The model shows that monetary policy easing reallocates liquidity and boosts lending, but also raises run risk. It reveals a macroprudential trade-off: a regulatory limit on interbank funding weakens monetary policy transmission but reduces systemic risk.
-
-
Copy CitationKaiji Chen, Yiqing Xiao, and Tao Zha, "A Trade-off Between Monetary Policy Transmission and Systemic Risk," NBER Working Paper 34056 (2025), https://doi.org/10.3386/w34056.Download Citation
-
Published Versions
Kaiji Chen & Yiqing Xiao & Tao Zha, 2026. "A trade-off between monetary policy transmission and systemic risk," Journal of Monetary Economics, .
Related
More from the NBER
In addition to working papers, the NBER disseminates affiliates’ latest findings through a range of free periodicals—the NBER Reporter, the NBER Digest, the Bulletin on Health, the Bulletin on the Economics of Alzheimer's, and the Bulletin on Entrepreneurship—as well as research spotlights, lectures, and panel videos.
