The Role Of Capital Regulation And Risk-Taking By Banks In Monetary Policy

The credit boom prevailing in the period preceding the last financial crisis was prolonged and associated with neither particularly strong output growth nor rising inflation in economies in which it occurred. This type of credit cycle and financial cycle is hard to reconcile with existing economic theory applied in monetary policy. In this paper we point out to endogenous factors behind this phenomenon. We aim to identify what is the role of bank capital regulation and bank risk-taking in the transmission mechanism of monetary policy. The transmis-sion of monetary policy impulses through capital channel is a diversified process, and depends on bank specific, background macroeconomics’s specific and other factors. Bank capital standards affect the banks’ perception, management and pricing of risks. In this area, monetary policy is also of great importance, with prominent role of the so called risk-taking channel in which central banks actions have an impact on bank risk attitudes. Consequently monetary policy is not fully neutral from a financial stability perspective. Stable level of inflation does not guarantee the stability of financial system. Therefore central banks in their con-duct of monetary policy should constrain the build-up of financial imbalances.