Inflation volatility effects on the allocation of bank loans

• Inflation volatility distorts the allocation bank loans.
• Bank managers behave conservatively when inflation volatility is high.
• Analyze a large panel of commercial bank data from 15 countries.
• Observations hold true for the full data, EU and non-EU country groups.

This paper examines the distortionary effects of inflation volatility on the allocation of bank loans. We argue that inflation volatility would render bank managers to behave more conservatively in issuing new loans. In contrast, when inflation volatility is low, bank managers would have the latitude to lend more idiosyncratically. Using a large panel of commercial bank data gathered from 15 countries, we provide support for our hypothesis by demonstrating a strong negative relation between inflation volatility and the dispersion of loans-to-assets ratio. Similar results are obtained when we split the sample between EU and non-EU country groups. The robustness of our findings is confirmed by a battery of sensitivity checks.