The transmission of monetary policy through bank lending: The floating rate channel

•Most bank loans feature floating rates mechanically tied to monetary policy rates.•Monetary policy affects the balance sheet strength of firms that use unhedged floating rate loans.•Constrained firms with more unhedged bank debt respond more to monetary policy.•This mechanism operates through outst...

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Bibliographic Details
Published in:Journal of monetary economics 2018-05, Vol.95, p.49-71
Main Authors: Ippolito, Filippo, Ozdagli, Ali K., Perez-Orive, Ander
Format: Article
Language:English
Subjects:
Bank debt
Financial constraints
Floating interest rates
Hedging
Monetary policy transmission
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Summary:•Most bank loans feature floating rates mechanically tied to monetary policy rates.•Monetary policy affects the balance sheet strength of firms that use unhedged floating rate loans.•Constrained firms with more unhedged bank debt respond more to monetary policy.•This mechanism operates through outstanding bank loans instead of new loans.•The significant effects of this mechanism disappear at the zero lower bound. Unlike other debt, most bank loans have floating rates mechanically tied to monetary policy rates. Hence, monetary policy can directly affect the liquidity and balance sheet strength of firms through existingloans. We show that firms—especially financially constrained firms—with more unhedged loans display a stronger sensitivity of their stock price, cash holdings, inventory, and fixed capital investment to monetary policy. This effect disappears when policy rates are at the zero lower bound, revealing a new limitation of unconventional monetary policy. The floating-rate channel is at least as important as the bank lending channel operating through new loans.
ISSN:0304-3932
1873-1295
DOI:10.1016/j.jmoneco.2018.02.001