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Interest rates, capital and bank risk-taking

Jonathan Acosta-Smith ()
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Jonathan Acosta-Smith: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 774, Bank of England working papers from Bank of England

Abstract: Are low interest rates more likely to incentivise greater bank risk-taking? This is the question we seek to answer. Using a model in which banks raise funds from depositors to create an investment portfolio which can differ in its risk and return, we suggest so. In particular, we show that lowering the interest rate makes it more likely banks will make risky investments. This is because reducing the interest rate makes safer assets less attractive, while increasing the relative gains from gambling. We show that risk-taking is highly dependent on banks’ skin-in-the-game, as banks always ignore the full extent of losses on bankruptcy. Raising the interest rate has a similar effect. It reinforces this behaviour, as by increasing the yield on the portfolio, banks have more to lose on bankruptcy.

Keywords: Banking; monetary policy; risk-taking; interest rates (search for similar items in EconPapers)
JEL-codes: E44 E58 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
Date: 2018-12-21
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0774

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