The monetary policy pass-through mechanism: Is the search-for-yield incentive at work?

This paper investigates the mechanism linking monetary policy and bank lending/risk-taking. Using data from Vietnamese commercial banks (2007-2019), the study finds that monetary policy's impact on bank output stems from banks' search-for-yield incentives. Lower interest rates during monetary expansions lead to more aggressive lending and risk-taking to offset reduced revenues. This supply-side effect also impacts the bank liquidity creation channel, with demotivated banks undermining monetary policy's influence on liquidity in the real economy. The findings are robust across various monetary policy indicators, bank output measures, and econometric methodologies, highlighting the need for monetary authorities to consider this mechanism when setting policy.

Japan Huynh