Does monetary policy act as a constraint on the quantity of bank credit? Does it affect banks’ risk-taking? Do markets monitor banks’ risk-taking behavior? These questions have important implications on our understanding of the consequences of monetary policy and—in light of recent financial crises—on the design of macro-prudential regulation. I address these question in the context of thrifts--U.S. banks that specialize in mortgage lending--in the years preceding the Sub-prime Crisis. Exploiting loan-level data on banks’ lending, I find that the effects of monetary policy do not conform to traditional theories of the bank lending channel: the quantity of small banks’ lending is not especially sensitive tomonetary policy--it is larger banks that are considerably more responsive. I also examine the cross-sectional effects of monetary policy on banks’ risk-taking. Using a novel contemporaneous measure of banks’ risk-taking that I construct from loan approval data, I find that less-capitalized banks’ increase risk-taking more in response to loose policy. This finding suggests that loose policy leads to excessive risk-taking in the presence of agency problems between bankowners and bank liability holders. Finally, I find mixed evidence on the role of market monitoring. Following the economic turmoil of 2001, the market for bank deposits appeared to take note of the differences in the riskiness of banks’ assets; however, the effect declined gradually over the next few years—by the eve of the Sub-prime crisis,it was not measurable.
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