Vector Autoregressive Modeling of Interest Rate Shocks on Bank Balance Sheets: A Comparative Study

Abstract

Di Tella and Kurlat (2017) and Drechser et al. (2017a) study the effects of a nominal interest rate shock on various bank balance sheet variables. I study the same relationships using a VAR model, to understand them over multiple periods of time, without assumptions of exogeneity, and with clear interactions between variables through impulse response functions (Hamilton 1994). I find that an increase in the nominal interest rate is associated with a much smaller increase in the rate banks pay on deposits and other expenses. Furthermore, an interest rate shock does not have much effect on bank net worth. This finding is important because previously banks were thought to be very sensitive to interest rate movements through their maturity transformation business model (Drechsler et al., 2017a).