Bank Capital and Risk Taking: A Loan Level Analysis

86 Pages Posted: 17 Oct 2017

See all articles by Michael Ohlrogge

Michael Ohlrogge

New York University School of Law

Date Written: September 9, 2017

Abstract

Does high leverage incentivize banks to systematically originate and hold riskier loans? I construct a novel data set consisting of 3 million small business and home mortgage loans, matched to the specific banks that originated them and verified to be held on bank portfolios, rather than sold. I measure the capital ratio (the inverse of the leverage ratio, defined as equity divided by asset value) for each bank at the time of each loan’s origination. After controlling for both bank and time fixed effects, a one point increase in Tier 1 capital ratios (e.g. from 12% to 13%) is associated with a 4.9% decrease in the default risk of mortgage loans held on portfolio (from a mean foreclosure rate of 4.3% to 4.1% for loans originated between 2003 and 2012). When considering the average capital of banks in US counties between 2003 and 2006, a one point increase in Tier 1 capital ratios is associated with a 4.4% reduction in foreclosures between 2007 and 2012. These results are robust to an instrumental variables strategy for predicting bank capital, a wide range of measures of bank capital, different types of banks, types of loans, and time periods.

Keywords: Bank Capital, Asset Substitution, Portfolio Risk, Mortgages, Small Business Loans[comma separated]

JEL Classification: G11, G21, G28, G32, G38]

Suggested Citation

Ohlrogge, Michael, Bank Capital and Risk Taking: A Loan Level Analysis (September 9, 2017). Available at SSRN: https://ssrn.com/abstract=3053240 or http://dx.doi.org/10.2139/ssrn.3053240

Michael Ohlrogge (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States

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