Leverage and Risk in US Commercial Banking in the Light of the Current Financial Crisis

Luxembourg School of Finance (LSF) Research Working Paper Series, No 10-12

26 Pages Posted: 15 Mar 2010 Last revised: 15 Nov 2013

See all articles by Christian C. P. Wolff

Christian C. P. Wolff

University of Luxembourg - Luxembourg School of Finance; Centre for Economic Policy Research (CEPR)

Nikolaos I. Papanikolaou

Bournemouth University - Business School

Multiple version iconThere are 2 versions of this paper

Date Written: March 14, 2010

Abstract

In this paper we study the relationship between leverage and risk in commercial banking market. We employ a panel data set that consists of the biggest US commercial banks and which extends from 2002 to 2010 thus covering both the years before the outbreak of the current financial crisis as well as those followed. We make clear distinctions among different leverage types like on- and off-balance sheet leverage as well as short- and long-term leverage, which have never been made in the relevant literature. Our findings provide evidence that excessive leverage, both explicit and hidden off-the-balance sheet, rendered large banks vulnerable to financial shocks thus contributing to the fragility of the whole banking industry. In a similar vein, a direct link between short- and long-term leverage with risk is reported before the crisis, showing that leverage has been one of the key factors responsible for the serious liquidity shortages that were revealed after 2007 when the crisis erupted. We also demonstrate that banks which concentrate on traditional banking activities typically carry less risk exposure than those that are involved with modern financial instruments. Overall, our results provide a better understanding of the role of leverage in destabilizing the whole system whereas at the same time contribute to the current discussion on the resilience of the banking sector through the strengthening of the existing regulatory framework.

Keywords: financial crisis, risk, leverage, commercial banking

JEL Classification: C23, D02, G21, G28

Suggested Citation

Wolff, Christian C. P. and Papanikolaou, Nikolaos I., Leverage and Risk in US Commercial Banking in the Light of the Current Financial Crisis (March 14, 2010). Luxembourg School of Finance (LSF) Research Working Paper Series, No 10-12, Available at SSRN: https://ssrn.com/abstract=1570505 or http://dx.doi.org/10.2139/ssrn.1570505

Christian C. P. Wolff

University of Luxembourg - Luxembourg School of Finance ( email )

4, rue Albert Borschette
Luxembourg, 1246
Luxembourg

HOME PAGE: http://www.lsf.lu

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Nikolaos I. Papanikolaou (Contact Author)

Bournemouth University - Business School ( email )

Executive Business Centre, 89 Holdenhurst Road,
Bournemouth, BH8 8EB
United Kingdom
+44 (0) 1202 968769 (Phone)

HOME PAGE: http://staffprofiles.bournemouth.ac.uk/display/npapanikolaou

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