Judging Banks' Risk by the Profits They Report

53 Pages Posted: 10 May 2018 Last revised: 8 Jun 2018

See all articles by Ben S. Meiselman

Ben S. Meiselman

Johns Hopkins University

Stefan Nagel

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research; CESifo (Center for Economic Studies and Ifo Institute)

Amiyatosh K. Purnanandam

University of Michigan, Stephen M. Ross School of Business

Date Written: April 26, 2018

Abstract

In competitive capital markets, portfolios of risky debt claims have high systematic risk exposure in bad times if they offer a high "yield" in good times. We apply this idea to measurement of bank risk. Rather than trying to directly measure asset risks on the balance sheet — the typical (manipulation-prone) approach in model-based regulation — we explore high rates of profit in good times as an indicator of systematic tail risk exposure. We show empirically, for cross-sections of banks in the financial crisis of 2007–2008 as well as the savings and loan crisis of the 1980s, that high accounting profitability prior to the crisis predicts high systematic tail risk of equity market values during the crisis, and most strongly so if pre-crisis profits arise from non-interest income or are paid out as dividends and managerial compensation. Pre-crisis profit measures do a better job in predicting systematic tail risk than conventional measures based on risk-weighted assets.

Keywords: Risk of Financial Institutions, Systemic Risk, Risk Measurement

JEL Classification: G20, G30

Suggested Citation

Meiselman, Ben S. and Nagel, Stefan and Purnanandam, Amiyatosh K., Judging Banks' Risk by the Profits They Report (April 26, 2018). Available at SSRN: https://ssrn.com/abstract=3169730 or http://dx.doi.org/10.2139/ssrn.3169730

Ben S. Meiselman (Contact Author)

Johns Hopkins University ( email )

Baltimore, MD 20036-1984
United States

Stefan Nagel

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research ( email )

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Amiyatosh K. Purnanandam

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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