Bank Capitalization Heterogeneity and Monetary Policy

WP BdE

Abstract:
This paper shows that heterogeneity in bank capitalization ratios plays a crucial role in the transmission of monetary policy to bank lending. I provide new empirical evidence that highly capitalized banks reduce their lending more after a monetary tightening, even after controlling for bank liquidity, size, and deposit market power. I also document that these banks have riskier portfolios and experience higher loan default rates after a tightening.

To rationalize these findings, I construct a dynamic macroeconomic model where banks differ in their recovery technologies and face risk-weighted capital constraints. Highly capitalized banks, which hold riskier loans, are more constrained and reduce credit supply more following a rate hike. A policy counterfactual shows that higher capital requirements amplify the contractionary effects of monetary policy.

JEL Codes: E43, E52, E58, E60, G21. Keywords: monetary policy, bank capital, heterogeneity, credit supply.