IMFS Working Paper on lending standards in times of expansionary monetary policy

What happens to the lending standards of banks in times of expansionary monetary policy?

One of the explanations of the credit boom that led to the recent financial crisis is that banks took excessive risks because of monetary policy rates had been “too low for too long”. In their new IMFS Working Paper, Afanasyeva and Güntner show that low monetary policy rates may also induce banks to lower their lending standards that is to grant more and riskier loans. In their analysis, IMFS researcher Afanasyeva and Güntner, Assistant Professor at the University of Linz, have focused on U.S. banks’ risk attitude before the financial crisis. They found out that the U.S. banks significantly lowered their lending standards, such as the collateral requirements for firms, in response to an unexpected reduction in interest rates. Thus, the banks want to gain a larger “share of the pie”. This effect increases with the degree of interest-rate smoothing in the monetary policy rule. As a consequence, companies become more leveraged and thus more likely to default.

IMFS Working Paper No. 85
Elena Afanasyeva and Jochen Güntner
"Lending Standards, Credit Booms and Monetary Policy"
(PDF, 546 KB)