Expansionary Federal Monetary Policy and U.S. Banks’ Risk Profiles During the COVID-19 Pandemic-Induced Economic Recession

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This study focuses on the pandemic phase when the U.S. economy dealt with significant economic recessionary pressures due to widespread, prolonged social mobility restraints. The Federal Open Market Committee (FOMC) promptly pursued expansionary policies, such as lowering the federal funds rate to almost zero until February 2022. This study employs a Dynamic Panel Data Generalised Moment Method Model (DPD-GMM) to analyse the impact of the COVID-19 pandemic’s economic shocks and FOMC’s expansionary policy on U.S. banks’ loan portfolio and asset complement risk profiles. Our analysis extends from two pre-pandemic years through the pandemic recession and recovery periods (until early 2022) prior to the FOMC’s eventual aggressive rate hiking policies intended to attenuate consequent inflationary conditions. Our findings clarify that banks’ risk exposure can be driven by both uncontrolled and discretionary portfolio decisions. Economic shocks beyond the banks’ control (such as the pandemic) could suddenly discredit historical lending decisions as economic slowdowns indiscriminately affect even clients previously assessed as creditworthy. Thus, banks experience more pronounced loan portfolio risk due to rising non-performing loan (NPL) balances. Meanwhile, the FOMC’s expansionist low interest-rate policy provides relief for banks who use their discretion in resolving their compounding liquidity concerns. These decisions, however, increase their risk asset holdings characterised by greater vulnerability to economic fluctuations. Our study’s implications call for more cautious management of banks’ risk profiles under difficult economic periods through prudent asset purchase decisions, greater loan diversification strategies, and more equitable financial market access for smaller and specialised (such as agricultural) banks.