Central Bank Funding and Credit Risk-Taking

Abstract

RESEARCH QUESTIONThe broader liquidity support programs, which the European Central Bank (ECB) employed in order to counteract the consequences of the global financial crisis of 2007-2008 and the sovereign debt crisis of 2010-2012, went way beyond the operational scope of classical monetary policy in several directions. For example, the ECB extended the pool of eligible collateral and introduced a full allotment strategy. Most notably, in the framework of its longterm refinancing operations (LTROs), the ECB substantially increased the maturity spectrum of central bank refinancing, providing loans to banks in the euro area with a maturity of up to three years. In this paper, we examine the following question: How did the extended liquidity provisions affect credit risk-taking? Specifically, how does central bank refinancing affect banks' loan supply to borrowers with different ex-ante risk levels? In this regard, we focus on the effect of the maturity extension and explicitly differentiate between short-term and long-term central bank funding (CBF). CONTRIBUTIONThese non-standard refinancing operations motivated recent research to revisit the issue of how monetary policy affects bank lending. This strand of the literature shows that the interventions have been successful in increasing bank lending volumes, thus counteracting contractions in aggregate credit and investment. We contribute to this literature by investigating the quality composition of banks' loan portfolios. By explicitly differentiating between short-term and long-term central bank funding, our results also add to the literature on the implications of bank funding maturities for the risk-taking incentives of banks. Finally, we also contribute to the policy debate on adequacy of potential macroprudential instruments and the ex-post effects of the expansionary monetary policy.