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September 10, 2025

The Moderating Role of Bank Risk in the Transmission of Monetary Policy Effects on Liquidity Creation Across the Business and Financial Cycles

Key Points

High-risk banks experience amplified contractionary impacts during downturns, reducing liquidity creation and profitability.
Low-risk banks demonstrate greater resilience against tightening monetary policies, ensuring better credit availability.
Utilizing data from 9,204 commercial banks across multiple economies, the study employs a two-step system GMM approach.
Insights suggest the integration of macroprudential measures with monetary policy to enhance financial system stability.

Abstract

This comprehensive study investigates the moderating effect of bank risk on the transmission of monetary policy (MP) to bank liquidity creation (BLC) and performance (BPER) across various financial and economic cycles. Utilizing data from 9,204 commercial banks in developed, developing, and emerging economies spanning 2000–2021, it applies a two-step system GMM approach to address endogeneity and autocorrelation. Results underscore the pivotal role of bank risk in shaping MP effects, revealing that high-risk banks experience amplified contractionary impacts during downturns, while low-risk institutions exhibit greater resilience. These insights call for the integration of risk-based considerations into macroprudential policy frameworks to ensure financial stability across diverse economic conditions. Additionally, the analysis highlights the interconnectedness of bank-specific characteristics, macroeconomic conditions, and policy measures in determining the scale and nature of MP transmission. High-risk banks not only experience greater liquidity contraction under tightening policies but also exhibit more pronounced declines in profitability, with implications for credit availability and overall financial system stability. This nuanced understanding underscores the need for differentiated policy approaches that consider individual bank profiles and systemic vulnerabilities. The study further reveals that the integration of MP and macroprudential measures is essential to enhance resilience in times of economic turbulence. By Byrecognizing the differential effects of policy changes on banks with varying risk exposures, policymakers can develop more targeted interventions, including dynamic capital buffers and liquidity support mechanisms, to sustain financial stability and support economic growth. This integrated approach not only mitigates risks but also strengthens the adaptability of the financial system to evolving challenges.

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