Monetary policy, bank leverage and liquidity

Abstract

Purpose: The study explores how banks design their financial structure and asset portfolio in response to monetary policy changes. Design/methodology/approach: The authors conduct the research design for the Vietnamese banking market during 2007–2018. To ensure robust findings, the authors employ two econometric models of static and dynamic panels, multiple monetary policy indicators and alternative measures of bank leverage and liquidity. Findings: Banks respond to monetary expansion by raising their financial leverage on the liability side and cutting their liquidity positions on the asset side. Further analysis suggests that larger banks' financial leverage is more responsive to monetary policy changes, while smaller banks strengthen the potency of monetary policy transmission toward bank liquidity. Additionally, the authors document that lower interest rates induce a beneficial effect on the net stable funding ratio (NSFR) under Basel III guidelines, implying that banks appear to modify the composition of liabilities to improve the stability of funding sources. Originality/value: The study is the first attempt to simultaneously examine the impacts of monetary policy on both sides of bank balance sheets, across various banks of different sizes under a multiple-tool monetary regime. Besides, understanding how banks organize their stable funding sources and illiquid assets amid monetary shocks is an innovation of this study.