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Monetary policy's risk-taking channel and leverage in bank-based financial systems: Evidence from the post-GFC euro area

We present evidence for the euro area of a risk–taking channel of monetary policy induced by a low interest rate environment following the 2008 Global Financial Crisis (GFC). Based on dynamic panel techniques, we find that credit risk (measured ex–ante and ex–post) is negatively associated with variations in interest rates, while competition in national banking industries tends to enhance this effect. Such negative relationship is also most pronounced for banks with relatively high levels of leverage, which is consistent with a "search for yield" effect. Eventually, we identify nonlinearities depending on the level of bank capitalization. These findings for the euro area are strikingly different from the U.S. banking industry, confirming that time, geographical circumstances, and local banking market conditions are key in understanding the impact of monetary policy on credit risk. This paper also points to the importance for theoretical literature to consider alternative channels of risk-taking in addition to traditional portfolio rebalancing channels.