Real interest rates, leverage, and bank risk-taking

Professor Robert Marquez

Co-Authors: Giovanni Dell’Ariccia & Luc Laeven

This paper studies how changes in real interest rates, resulting from changes in monetary policy, capital liberalization, or other changes in macroeconomic conditions, affect banks’ portfolio choices.  In a theoretical model, we show that reductions in real interest rates cause banks to increase their leverage (i.e.., finance themselves with more debt), expand their portfolios by lending more, and take on more risk, thus making them more prone to failure.