Non-conventional monetary policy seems to benefit banks’ balance sheets. After all, it offers cheap refinancing and credit market support. However, an empirical analysis by Lambert and Ueda casts doubt on that belief. Market measures of bank credit risk have mostly deteriorated in episodes of policy stimulus. Easy monetary policy has been encouraging risk-weighted asset accumulation and discouraging balance sheet repair.
Lambert Frederic, and Kenichi Ueda (2014), “The Effects of Unconventional Monetary Policies on Bank Soundness”, IMF Working Paper 14/152
The below are excerpts from the paper. Emphasis and cursive text have been added.
In a nutshell
“Unconventional monetary policy is often assumed to benefit banks. However… we find some evidence for heightened medium-term risks, which is likely due to delayed balance sheet repair by banks. These findings are the result of two sets of analyses: an event study on bank stock valuation and credit risk, and panel regressions on bank level measures of profitability, risk taking, and balance sheet repair.”
“The event-study regressions show that bank credit risk increases with monetary easing over the medium term without clear effects on bank stock valuation.”
“We compare the average effects on banks of unconventional monetary policies with those of conventional monetary policies. We do so by regressing daily bank stock returns and daily changes in credit risks on monetary policy surprises on (almost) all FOMC announcement days since 2000. We define the conventional monetary policy period as the period before August 2007 while the so-called unconventional policy period starts after the collapse of Lehman Brothers on September 16, 2008.”
“As our benchmark [monetary policy] surprise measure we use one-year-ahead futures of the three-month Eurodollar rate. This is because the one-year-ahead futures rate is less affected by the zero lower bound…[As an alternative measure we] counted the number of news articles on monetary policy three days before and after each policy announcement [and]…collected the numbers of “positive” and “negative” news references in terms of monetary easing.”
“We regress daily bank stock returns and daily changes in spreads between bank corporate bond yields and the Treasury bond yields on the surprise component of the monetary policy announcements…The effect of conventional monetary policy surprises on bank stock daily returns…in both conventional and unconventional policy periods is not significant [in the U.S.]…For the euro area and the United Kingdom, bank stock prices fall with monetary easing.”
“However, we found negative, significant effects of monetary easing on bank credit risk…Roughly speaking, 1 basis point of monetary easing increases the credit spread by about 0.1 basis point…The common effects of both conventional and unconventional monetary policies on bank credit risk remain significant over all sample years.”
“We examine the effects of low interest rates…and central banks’ asset purchases on banks’ profitability, risk taking, and balance sheet repair using bank-level data for the United States over the period 2007–2012. The panel analysis looks for any symptoms of risk already present in banks’ balance sheets.”
“While unconventional monetary policies do not appreciably affect the profitability of banks, they seem to reinforce banks’ soundness by allowing them to reduce leverage and extend the maturity of their debt. However, a prolonged period of low interest rates is also associated with an increase in the ratio of risk-weighted assets to total assets. In addition, we find that increases in central banks’ balance sheets could delay loss provisioning for existing loans, thereby potentially increasing the overall credit risk as also found in the event study results.”