Abstract - Hazardous Times for Monetary Policy: What Do Twenty-Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk?

We investigate the impact of the stance and path of monetary policy on the level of credit
risk of individual bank loans and on lending standards. We employ the Credit Register of
the Bank of Spain that contains detailed monthly information on virtually all loans granted
by all credit institutions operating in Spain during the last twenty-two years – generating
almost twenty-three million bank loan records in total. Spanish monetary conditions were
exogenously determined during the entire sample period.
Using a variety of duration models we find that lower short-term interest rates prior to loan
origination result in banks granting more risky new loans. Banks also soften their lending
standards – they lend more to borrowers with a bad credit history and with high uncertainty.
Lower interest rates, by contrast, reduce the credit risk of outstanding loans. Loan credit
risk is maximized when both interest rates are very low prior to loan origination and interest
rates are very high over the life of the loan. Our results suggest that low interest rates
increase bank risk-taking, reduce credit risk in banks in the very short run but worsen it in
the medium run.
Risk-taking is not equal for all type of banks: Small banks, banks with fewer lending
opportunities, banks with less sophisticated depositors, and savings or cooperative banks
take on more extra risk than other banks when interest rates are lower. Higher GDP growth
reduces credit risk on both new and outstanding loans, in stark contrast to the differential
effects of monetary policy.

Jose Luis Peydro-Alcalde
20.Nov 2007

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