Bank Risks, Risk Preferences and Lending

BankRisks,RiskPreferencesandLendingPreliminaryandincompleteTomaszChmielewskiMay9,2005AbstractTherecentdebateontheimpactofcapitalregulationonbankbehav-iourshowsthatriskexposuresofbanksmightin‡uencetheamountofloansnewlygrantedtothenon-…nancialsector.Thepaperanalysesimplicationsofthisrelationshipfortheroleof…nancialstabilityanalysisintheconductofmonetarypolicy.Thisrolestemsfromthefactthatthe…nancialinstabil-itycanin‡uencethemonetarytransmissionmechanism.Afteramonetarypolicyshockthemarketpriceofriskandloanlossdistributionchange.Thecreditspreadsforloansalreadygrantedmightthenbenotenoughtocoverexpectedlossesandthedefaultprobabilityofabankincreases.Ifthebankintendstomaintainthepreviousleveloftheprobabilityofdefault,eitheradditionalcapitalorachangeintheassetstructureisneeded.Thisconsti-tutesanadditionalwayinwhichmonetarypolicymightin‡uencethesupplyofbankloans.TheimplicationsofthepresentedmodelaretestedusingthedataforthePolishbankingsectorduringtheperiod1997-2004.Assuminghomogeneityofborrowersacrossbanksitisshownthatvariablesproxyingbankriskpreferencesandthelevelofriskundertaken(alsowheninteractedwithamonetarypolicymeasure)aresigni…cantinregressionsexplainingchangesintheamountofbankloansupply.NationalBankofPoland,FinancialSystemDepartmentandWarsawSchoolofEconomics,ChairofMonetaryPolicy([e-mail]).ApartoftheresearchpresentedinthepaperwasconductedduringmyvisitattheEuropeanCentralBank,DirectorateGeneralResearch.IwouldliketothankM.Brzoza-Brzezina,M.Ehrmann,A.G÷ogowski,P.Hartmann,M.Kolasa,K.-G.Lindquist,T.Opiela,D.SerwaandZ.Pola´nskiforveryusefuldiscussions,commentsandsuggestionsatthedi¤erentstagesoftheproject.Allerrorsandomissionsre-mainmyown.ThepaperpresentsonlymyviewsandopinionsandnotnecessarilythoseoftheinstitutionsIama¢liatedwith.11.IntroductionThe…nancialsystems’abilitytoprovide…nancialintermediationservicesinanundisturbedande¢cientwayisoneofthemajorissuesinthe…nancialstabilityanalysis.Itisconsideredtoconstitutea…nancialsystem’scontributiontogrowthopportunitiesofthewholeeconomy.Therecentdebateontheimpactofcapitalregulationonbankbehaviourshowsthatriskexposuresofthebanksmightin‡u-encetheamountofloansgrantedtothenon-…nancialsector(e.g.FrootandStein,1998;Fur…ne,2001;CebenoyanandStrahan,2004;Repullo,2004).Ontheotherhand,thereisstillanunresolvedproblemofthenatureoftherelationshipbetweenthe…nancialandmonetarystability.Especially,itreferstotheextenttowhichmonetarypolicymakersshouldtake…nancialstabilityissuesintoconsideration.Thispapercombinesboththeseaspects.Monetarypolicydecisionsin‡uencethestructureofbanks’riskpro…lesandmarketriskpricing.Inreactiontothecentralbankbehaviour,commercialbanksadjusttheirbalancesheets.Thesead-justmentsin‡uencetheloansupplyasbankriskappetitechanges.However,ifthestabilityofthebankingsectorhadbeenalreadyimpaired,theincreasedriskinessofbankassetsmightbecomeanobstacleforsmoothfunctioningofthe…nancialintermediationprocessandresultinalargedecreaseinbankloansupply.Toavoidalargerthanexpectedoutputreaction,itmightbebene…cialformonetaryauthor-itiestomonitorthebehaviourand…nancialstandingof…nancialintermediaries.Theprobleminhandiscloselyrelatedtotheanalysisofthemonetarytransmis-sionmechanismandmightbede…nedasananalysisofthebanklendingchannelinthe…nancialstabilitycontext.Afteramonetarytighteningthemarketpriceofriskandloanlossdistributionchange.Thecreditspreadsfortheloansalreadygrantedmightthenbenothighenoughtocoverexpectedlossesandthedefaultprobabilityofabankincreases.Ifthebankintendstomaintainthepreviousleveloftheprobabilityofdefault,eitheradditionalcapitalorachangeintheassetstructureisneeded.Asraisingnewcapitalisusuallycostly,thelattersolutionmightbetheonlyavailableoneforthebankintheshortrun.Inthisrespectthebankreactionstemsonlyfromthepresentbalancesheetstructure(beingaresultofpreviousdecisions)andre‡ects,interalia,abank’srisktakingstrategy.Thisconstitutesanadditionalwayinwhichmonetarypolicymightin‡uencethesupplyofbankloans.Unlikethetraditionaltheoryofthebanklendingchannel(e.g.KashyapandStein,1995),thepresentedargumentdoesnotrelyonbanksbeingconstrainedbyreserverequirements1.Itmightbe,therefore,moresuitableforeconomieswerecentralbanksfollowthedirectin‡ationtargetingstrategy.Thereasoningpresentedinthispaperisalsodistinctfromthebankcapitalchannel1Itisalsodistinctfromtheborrowers’balancesheetchannel(e.g.Kashyapetal.,1993;GertlerandGilchrist,1994),asitdoesnotrefertonewlendingopportunities.2(VandenHeuvel,2002),asthecapitalconstraintisratherendogenous2(e.g.Bar-riosandBlanco,2003).Banksareassumedtousecapitalallocationasapartoftheirinternalriskmanagementprocedures.Ifthemonetarypolicyreallyin‡uencestheloansupplybecausebanksadjusttheirlendingtochangesintheirassetrisk,theeconometricspeci…cationusedtotestthebanklendingchannelshouldbeaugmentedwithvariablesproxyingbankriskpreferencesandthelevelofriskpresentinbankbalancesheets(i.e.assetquality).Thispaperproposestheshareofloanstothenon-…nancialsectorintotalassetsandtheshareofloansgrantedtohouseholdsintheloanstothenon-…nancialsectorasproxiesforbanka