Bank risk and monetary policy

Abstract

We find evidence of a bank lending channel operating in the euro area via bank risk. Financial innovation and the wider use of new ways of transferring credit risk have tended to diminish the informational content of standard bank balance sheet indicators. We show that bank risk conditions, as perceived by financial market investors, need to be considered, together with the other indicators (i.e., size, liquidity and capitalization), traditionally used in the bank lending channel literature to assess banks’ ability and willingness to supply new loans. Using a large sample of European banks, we find that banks characterized by lower expected default frequency are able to offer a larger amount of credit and to better insulate their loan supply from monetary policy changes.