Research On The Bank Risk-taking Channel Of Monetary Policy In The Presence Of Market Frictions

When a central bank implements monetary policy,it communicates its impact to the real economy through a process called the monetary policy transmission mechanism,which involves various channels.In the traditional New Keynesian framework,the role of banks in this process was often overlooked.However,following the global financial crisis in 2008,there was a paradigm shift in monetary policy transmission that emphasized the importance of the link between monetary policy and financial stability.Financial intermediaries,such as banks,were found to play a key role in transmitting the effects of monetary policy to the broader economy and amplifying macroeconomic activities.To better understand how banks’ risktaking motives are influenced by monetary policy and how the banking sector can impact the macroeconomy,financial stability theory has analyzed the transmission channels of monetary policy,with a focus on the role of realistic market frictions.This paper introduces three specific forms of market frictions,namely incomplete information arising from economic uncertainty,changes in bank market power due to non-sufficient competition,and international monetary policy externalities.By considering these market frictions,the paper investigates their effects on the risktaking behavior of banks in response to monetary policy,both theoretically and empirically.The potential mechanisms and pathways through which these effects occur are also explored,with the aim of providing useful insights and policy recommendations for monetary authorities and financial regulators in formulating and optimizing monetary policy.Chapter 2 provides a theoretical foundation and literature review.Through theoretical analysis and a systematic review of the relevant literature,important possible gaps in existing research are identified regarding the impact of market frictions on the relationship between monetary policy and bank risk.In the theoretical foundations section,a theoretical overview of monetary policy transmission theory and market frictions theory is first presented.Most importantly,market frictions that exist in reality are incorporated into the analytical framework to analyze their mechanism of action and propose research hypotheses:(1)pointing out the problem of incomplete information in the market from the perspective of economic uncertainty,laying the theoretical foundation and proposing relevant research hypotheses based on the real options theory and the profit-seeking effect;(2)representing bank non-full competition in the market with micro-level market power,based on the franchise(2)The value hypothesis,the "quiet life" hypothesis,and the "too big to fail" hypothesis are used to represent the non-full competition of banks in the market,and the theoretical foundation and relevant research hypotheses are formulated.(3)Based on the triadic paradox,we point out the policy externality problem in the market,analyze the monetary policy spillover effect in the central economy(the United States),and propose the hypothesis of the existence or otherwise of the risk-taking channel of international monetary policy banks.In the literature review section,we first sort out the current status of domestic and international research on the risk-taking channel of monetary policy banks under ideal market conditions,then introduce information frictions and real frictions in the market in turn,and review and summarize the studies in the literature on the effects of economic uncertainty,bank market power and international monetary policy on bank behavior and monetary policy effectiveness.Overall,the theoretical analysis and literature review provide the basis for judging the extent to which the bank risk effect of monetary policy is affected by market frictions.Chapter 3 examines the impact of economic uncertainty on the monetary policy bank risk-taking channel.Based on the theoretical analysis,the following conclusions are obtained from the empirical tests using micro data of 43 listed commercial banks in developed and emerging economies from 2000 to 2018: first,bank risk is significantly affected by changes in monetary policy,with bank stability declining and risk-taking levels rising under accommodative monetary policy,confirming the existence of a bank risk-taking channel in the literature.Most importantly,the impact of monetary policy on bank risk is significantly weakened in times of rising economic uncertainty,supporting the research hypothesis proposed based on real options.Banks may pause to adjust their credit and risk management decisions in response to information incompleteness caused by economic uncertainty under market frictions,thus weakening the link between monetary policy and bank risk.Second,it is consistent with the underlying findings through a series of robustness tests.Moreover,the bank risk-taking channel is effective when the central bank implements conventional monetary policy,however,this transmission mechanism is not evident in periods of unconventional monetary policy.By distinguishing between accommodative and tight monetary policy stances,it is found that economic uncertainty induces banks to delay adjusting their risk-taking decisions when expansionary monetary policy is implemented.Economic uncertainty produces a heterogeneous effect on the bank risk effect of monetary policy in terms of bank subject characteristics,which is more pronounced among banks that are smaller,less liquid,or more income diversified.Finally,there are also different effects of monetary policy on banks’ leverage risk and portfolio risk under economic uncertainty,with uncertainty having a more pronounced effect on the latter.Chapter 4 explores the impact of bank market power on the risk-taking channel of monetary policy banks.The possible impact of bank market structure on bank behavior and monetary policy effectiveness is analyzed in the context of the debate between the "competition-fragility" and "competition-stability" perspectives,and research hypotheses are formulated.This chapter also uses microdata for listed commercial banks in 43 developed and emerging economies from 2000 to 2018 for empirical testing.First,using the efficiency-adjusted Lerner index to measure bank market power,it is found that stronger market power weakens the negative impact of monetary policy on bank stability.According to franchise value theory and the "quiet life" hypothesis,banks with stronger market power are more likely to act more prudently to protect their franchise value or to prefer a quiet life due to the presence of monopoly rents,reducing their incentive to take excessive risks.The basic findings pass a series of robustness tests.Second,in the heterogeneity analysis,the extent to which bank market power offsets the bank risk effect of monetary policy is found to be influenced by bank characteristics.The attenuating effect of bank market power on the risk effect of banks with higher profitability,lower liquidity and deeper capitalization is more pronounced under monetary policy shocks.Next,using the global financial crisis as a time point and dividing the pre-,mid-,and post-crisis periods,we find that the effect of monetary policy on bank risktaking is significantly weakened during the global financial crisis when bank market power is enhanced.In addition to individual bank risk,monetary policy affects the marginal contribution of banks to systemic risk,and bank market power likewise has a significant offsetting effect on the bank systemic risk effect of monetary policy.Chapter 5 examines the spillover effects of U.S.monetary policy on banks in emerging economies.Within the framework of the triadic paradox and open economics,the existence of an international monetary policy risk-taking channel is hypothesized by considering the externalities of monetary policy.Using micro data on commercial banks in 39 emerging market economies from 2000 to 2018,we explore the spillover effects of U.S.monetary policy on bank risk in emerging economies and find supportive evidence of an international monetary policy bank risk-taking channel.The study finds that the risk level of banks in each emerging economy increases significantly in response to an accommodative U.S.monetary policy shock.In robustness tests,replacing the proxy variables for bank risk and monetary policy separately,consistent results are found.In addition,different degrees of financial development and rule of law environments explain well the cross-country heterogeneity of U.S.monetary policy spillovers.When the Fed implements an accommodative monetary policy,the higher the degree of financial deepening in the emerging economies where banks are located,the higher the level of risk,i.e.,the lower the stability,of banks.In the analysis of bank heterogeneity,foreign banks are more exposed to the risk of U.S.monetary policy shocks than domestic banks.Banks with larger regulation and lower liquidity are also subject to stronger spillover effects of large U.S.monetary policy.Finally,separating out the unintended part of U.S.monetary policy,we find that there are still significant spillover effects of U.S.monetary policy "surprises" on bank risk in emerging economies.Based on the empirical evidence and findings presented in the study,several policy recommendations can be made.First,it is recommended to strengthen macroprudential regulation and supervision and coordinate monetary policy with macroprudential policy.This would involve establishing a regulatory framework for both monetary policy and macroprudential policy to prevent and mitigate financial risks and maintain financial stability while achieving economic objectives.Second,it is recommended to incorporate market frictions into policy analysis and implement differentiated monetary policies.The study highlights the importance of considering the impact of market frictions when formulating monetary policy,and recommends implementing differentiated monetary policies based on the type of market frictions present in the economy to improve the effectiveness of monetary policy.Third,the study suggests paying attention to the characteristics of bank subjects and coordinating macro-prudential and micro-prudential regulation and supervision.In addition to focusing on the overall systemic risk,the microprudential regulation and supervision should be carried out for banks with different characteristics.Finally,the study recommends promoting the reform of China’s financial system,strengthening and improving modern financial supervision,and keeping abreast of the macroeconomic policies of central economies such as the U.S.while being alert to adverse externalities.By implementing these policy recommendations,policymakers can better manage the risks associated with monetary policy and promote financial stability.