Central banks’ financial stability orientation and bank risk-taking

Abstract

The existing literature provides inconclusive theoretical predictions regarding whether central banks’ monetary policy should address financial stability. We therefore empirically evaluate the effect of central banks’ financial stability orientation (“leaning against the wind”) on bank risk-taking. Our baseline results from cross-country, bank-level panel data suggest that higher central banks’ financial stability orientation significantly reduces bank risk-taking. Further investigation shows that monetary policy aimed at achieving financial stability complements macroprudential policy in reducing bank risk-taking, particularly during macroprudential policy tightening. These results offer novel insights into the effect of central bank’s monetary policy on bank stability and provide empirical evidence to prior theoretical works.