Bank Profitability and Risk-Taking

44 Pages Posted: 3 Feb 2016

See all articles by Natalya Martynova

Natalya Martynova

De Nederlandsche Bank - Research Department

Lev Ratnovski

International Monetary Fund; European Central Bank, Financial Research Division

Razvan Vlahu

De Nederlandsche Bank

Date Written: November 2015


Traditional theory suggests that more profitable banks should have lower risk-taking incentives. Then why did many profitable banks choose to invest in untested financial instruments before the crisis, realizing significant losses? We attempt to reconcile theory and evidence. In our setup, banks are endowed with a fixed core business. They take risk by levering up to engage in risky 'side activities' (such as market-based investments) alongside the core business. A more profitable core business allows a bank to borrow more and take side risks on a larger scale, offsetting lower incentives to take risk of given size. Consequently, more profitable banks may have higher risk-taking incentives. The framework is consistent with cross-sectional patterns of bank risk-taking in the run up to the recent financial crisis.

Keywords: Risk-Taking, Repo Markets, Crises, bank, risk, bank risk, capital, Government Policy and Regulation, Crises.,

JEL Classification: G21, G24, G28

Suggested Citation

Martynova, Natalya and Ratnovski, Lev and Vlahu, Razvan, Bank Profitability and Risk-Taking (November 2015). IMF Working Paper No. 15/249, Available at SSRN:

Natalya Martynova (Contact Author)

De Nederlandsche Bank - Research Department ( email )

P.O. Box 98
1000 AB Amsterdam

Lev Ratnovski

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States


European Central Bank, Financial Research Division


Razvan Vlahu

De Nederlandsche Bank ( email )

P.O. Box 98
Amsterdam, 1000 AB
+31205242483 (Phone)
+31205242506 (Fax)

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