Monetary Shocks and Bank Balance Sheets
Pablo Kurlat
2016-08-24 - We propose a model to explain banks’ exposure to interest rate risk. Bank deposits provide liquidity so an increase in nominal interest rates, which raises the cost of liquidity, allows banks to earn higher spreads on deposits. If risk aversion is higher than one, banks choose to take losses when interest rates rise because they expect higher spreads looking forward. This can be achieved by a traditional maturity-mismatched balance sheet. The mechanism is quantitatively important and can match the level and time pattern of banks’ maturity mismatch, regardless of whether interest rates are driven by monetary or real shocks.