On Risk, Leverage and Banks: Do Highly Leveraged Banks Take on Excessive Risk?

Duisenberg School of Finance - Tinbergen Institute Discussion Paper TI 12-022/2/DSF31

27 Pages Posted: 19 Mar 2013

See all articles by Martin Koudstaal

Martin Koudstaal

University of Amsterdam; Tinbergen Institute

Sweder van Wijnbergen

Universiteit van Amsterdam; Tinbergen Institute; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: November 1, 2012

Abstract

This paper deals with the relation between excessive risk taking and capital structure in banks. Examining a quarterly dataset of U.S. banks between 1993 and 2010, we find that equity is valued higher when more risky portfolios are chosen when leverage is high, and that more risk taking has a negative impact on valuation of the debt of highly leveraged banks. We find no evidence that deposit insurance is encouraging risk taking behaviour. We do find that banks with a more troubled loan portfolio take on more risk. Banks whose share price has slumped tend to gamble for resurrection by increasing the riskiness of their asset portfolios. The results suggest that incentives embedded in the capital structure of banks contribute to systemic fragility, and so support the Basel III proposals towards less leverage and higher loss absorption capacity of capital.

Keywords: bank fragility, risk shifting, deposit insurance, gambles for resurrection

JEL Classification: G21, G28, G32

Suggested Citation

Koudstaal, Martin and van Wijnbergen, Sweder, On Risk, Leverage and Banks: Do Highly Leveraged Banks Take on Excessive Risk? (November 1, 2012). Duisenberg School of Finance - Tinbergen Institute Discussion Paper TI 12-022/2/DSF31. Available at SSRN: https://ssrn.com/abstract=2170008 or http://dx.doi.org/10.2139/ssrn.2170008

Martin Koudstaal

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Sweder Van Wijnbergen (Contact Author)

Universiteit van Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4011 / 4203 (Phone)
+31-35-624 91 82 (Fax)

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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