Endogenous Bank Risks and the Lending Channel of Monetary Policy

Gabriela Araujo, David Rivero Leiva and Hugo Rodríguez Mendizábal

No 1549, Working Papers from Barcelona School of Economics

Abstract: This paper develops a general equilibrium banking model where lending and payment flows endogenously link credit, liquidity, and solvency risks. Banks issue deposits at loan origination. As deposits circulate, reserve settlement creates liquidity exposure and repayment shortfalls generate credit and solvency risks. These risks are jointly determined by credit provision and bound balance sheet expansion at an internally determined profitability threshold rather than an external funding or capital limit. We present an application of the theory that provides a new look to the bank lending channel where monetary policy operates through the endogenous generation of bank risks. Our quantitative results align with empirical observations, including declines in deposit growth after monetary policy tightening and its different impact on lending depending on the balance sheet strength of banks as well as the relation of funding costs in interbank markets with liquidity and solvency ratios.

Keywords: banks; credit risk; interbank market; liquidity risk; monetary policy; payments; risk premium; solvency risk (search for similar items in EconPapers)
JEL-codes: E10 E44 E52 G21 (search for similar items in EconPapers)
Date: 2026-01
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