A balance sheet analysis of monetary policy effects on banks

Abstract

Monetary policy operations affect bank balance sheets (BBSs). This study develops a balance sheet model to examine the impacts of monetary policy operations on banks' ability to supply funds. That ability is assessed using the balance sheet capacities provided by regulatory risk management instruments. The balance sheet approach views a monetary policy operation as a transaction between the central bank and a commercial bank, modeling the transaction as multiple changes to the BBS. This study identifies and distinguishes the effects of multiple changes in the BBS on balance sheet capacity. A balance sheet change resulting from a monetary policy operation may positively or negatively affect balance sheet capacity. Thus, a monetary policy may have a positive and a negative effect simultaneously. Positive (negative) effects result from balance sheet changes that reduce (increase) bank risks, as measured by regulations. As regulatory stringency decreases, the positive effects increase, whereas the negative effects remain unchanged. A BBS capacity channel of monetary policy is also shown.