Bank portfolio management, monetary policy, economic uncertainty: The observations on million banks

This study presents the impacts of both monetary policy and the uncertainty of economic activity on bank portfolio management. The theoretical model employed in this study utilizes the model of Portfolio Optimization to demonstrate the mechanisms through which bank portfolio behavior are influenced by policies set by the Federal Reserve, and uncertainty of economic activity. Empirically analysis utilizing quarterly bank level data from the Federal Reserve database provides strong evidence that both monetary policy and uncertainty of economic activity impact bank portfolio management. In brief, I find that a tightening monetary policy decreases bank loans regardless of bank size and the types of loans. The overall impact from monetary policy is stronger on small and weak balance sheet banks relative to large and strong balance sheet banks. This is consistent with previous literature on credit channels. The impact of economic uncertainty on bank portfolio behavior, however, results in two distinct outcomes depending on the type of economic uncertainty. The results for uncertainty concerning output, inflation, labor markets, and long term credit markets indicate that higher uncertainty leads to a reduction in bank loans, while the results for uncertainty about stock markets, foreign exchange markets, and short term credit markets give the opposite outcome. The dichotomy in reaction concerning the two different types of economic uncertainty is best explained by considering the information contained within each type of uncertainty. In contrast to monetary policy impacts, it is the portfolios of large and strong balance sheet banks that respond more to economic uncertainty. Finally, this finds that monetary policy will have less impact on bank portfolio behavior during periods of high economic uncertainty, or in other words, economic uncertainty will have only limited impact in bank portfolio management during the period of expansionary monetary policy.