A Trade-off Between Monetary Policy Transmission and Systemic Risk

Kaiji Chen, Yiqing Xiao and Tao Zha

No 34056, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study how interbank funding links monetary policy transmission to systemic risk in a banking system with heterogeneous access to deposit funding. Using bank-level data from China, we show that monetary policy easing reallocates liquidity through the interbank market: large banks raise household demand deposits and lend in the interbank market, while small banks expand loans through interbank borrowing. During economic downturns, greater reliance on interbank funding is associated with higher systemic risk. To interpret these facts, we build a structural model with deposit-rich and deposit-poor banks and interbank rollover risk. The model shows that monetary policy easing reallocates liquidity and boosts lending, but also raises run risk. It reveals a macroprudential trade-off: a regulatory limit on interbank funding weakens monetary policy transmission but reduces systemic risk.

JEL-codes: E02 E5 G28 (search for similar items in EconPapers)
Date: 2025-07
New Economics Papers: this item is included in nep-cba, nep-cna, nep-mon and nep-sea
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Citations: View citations in EconPapers (4)

Published as Kaiji Chen & Yiqing Xiao & Tao Zha, 2026. "A trade-off between monetary policy transmission and systemic risk," Journal of Monetary Economics, .

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