How Does Belief Mismatch at the Repo Market Affect Banks' Risk Taking?

Ponente(s): Carlos Ivan Cañon Salazar, Adrián Pardo

Using proprietary data we evaluate a channel through which open-ended funds, an important type of shadow bank, can affect commercial banks’ risk taking at their regular lending activities. In particular, we study the effect of belief mismatches, between banks and mutual funds, at the repo market over the determination of asset prices, as well as over the willingness of banks to take further risk. We construct a simple model that combines Dell’Ariccia et al. (2014) and Simsek (2013) that support all hypotheses. Results indicate that indeed belief mismatch plays a relevant role in determining the spread between the repo rate and the reference rate, as well as in explaining different measures of banks’ risk taking. Optimistic beliefs concerning future payoffs allow both mutual funds and banks to accept greater risk, the decrease in risk aversion from the former is translated in decreases in the repo rate spread while that of the latter is translated in changes in the banks’ loan portfolio composition. Finally, we find that monetary policy’s search-for-yield effect on banks is exacerbated when they are more optimistic than open-ended funds.