infonet-economy

In this paper, we empirically analyze the transmission of realized interest rate risk - the gain or loss in a bank's economic capital caused by movements in interest rates - to bank lending. We exploit a unique panel data set that contains supervisory information on the repricing maturity profiles of Swiss banks and provides us with an individual measure of interest rate risk exposure net of hedging. Our analysis yields two main results. First, the impact of an interest rate shock on bank lending significantly depends on the individual exposure to interest rate risk. The higher a bank's exposure to interest rate risk, the higher the impact of an interest rate shock on its lending. Our estimates indicate that a year after a permanent 1 percentage point upward shock in nominal interest rates, the average bank in 2013Q3 would, ceteris paribus, reduce its cumulative loan growth by approximately 300 basis points. An estimated 12.5% of the impact would result from realized interest rate risk weakening the bank's economic capital. Second, bank lending appears to be mainly driven by capital rather than liquidity, suggesting that a higher capitalized banking system can better shield its creditors from shocks in interest rates.