Liquidity requirements and the risk taking channel of monetary policy
In this seminar, Professor Cyril Monnet will discuss implications of deposit making on risk taking.
Together with Stephan Imhof from the Swiss National Bank and Shengxing Zhang from London School of Economics, Professor Cyril Monnet's paper looks at the implications of deposit making on risk taking.
The researchers capture several important features of bank lending. Banks finance firms by creating deposits. Firms use these deposits as means of payments. Deposits carry a risk premium as long as they are not insured or only partially backed by liquid assets. Optimally the amount of deposits is restricted by some reserves or liquidity requirements.
The optimal combination of reserve or liquidity requirements and inflation trades-off investment and risk. Increasing these requirements or inflation makes loans to the private sector more expensive. This induces borrowers to take more risk, but they also invest less when loans are more expensive. As a result, leverage declines which then induces borrowers to take safer decision.