Dissecting The Risk-Taking Channel of Monetary Policy: A New Approach and Evidence from Peru

We adopt a different perspective on the risk-taking behavior of banks, focusing on how banks allocate loans across risky markets following a monetary policy shock in Peru. Utilizing a novel time series of identified monetary policy shocks, we first present robust evidence, at the aggregate level, indicating that credit market equilibrium is predominantly driven by supply forces. Subsequently, employing micro-data at the branch level, and an econometric strategy centered on local credit markets, and the geographic distribution of risk, we further demonstrate that the risk-taking channel constitutes a significant credit supply-side mechanism in the transmission of monetary policy. We use a theoretical model to illustrate that an expansionary monetary policy shock activates the risk-taking channel by modifying a bank's risk appetite and prompting a rebalancing of its loan portfolio, resulting in increased lending to riskier markets. Empirically, a branch-level estimation confirms that the sensitivity of lending to monetary policy changes escalates with the riskiness of borrowers. At higher levels of aggregation, these results retain both their economic and statistical significance. Additional estimations reveal that the risk-taking channel of monetary policy exerts a substantial impact on the total lending issued by financial institutions, regardless of their size. A closer examination, however, indicates that a significant portion of the dynamic responses of credit to monetary policy shocks predominantly occurs in markets below the median of the risk distribution.