Risk-taking Channel of Monetary Policy: Evidence from Indian Banking

Abstract

Some recent articles have studied the link between the central bank’s monetary policy stance and the risk-taking behaviour of banks in the context of advanced economies. Loose monetary policy can encourage banks to reach for yield, which will increase their share of risky assets, and also induce them to use more short-term funding. We empirically examine the existence of this risk-taking channel of monetary policy transmission in India. We find that expansionary monetary policy may increase default risk particularly for foreign banks and new private sector banks. We also find that tightening of monetary policy leads to lower liquidity risk and market risk and the effects are stronger for foreign banks than for other bank groups. In terms of market risk, the effect on foreign banks is weaker in cases of monetary tightening compared to expansion. JEL Classification: G21, G28, G32