Bank Profitability, Leverage Constraints, and Risk-Taking

62 Pages Posted: 21 Apr 2019

See all articles by Natalya Martynova

Natalya Martynova

Deutsche Bundesbank - Research Centre

Lev Ratnovski

International Monetary Fund; European Central Bank, Financial Research Division

Razvan Vlahu

De Nederlandsche Bank

Date Written: 2019

Abstract

Traditional theory suggests that higher bank profitability (or franchise value) dissuades bank risk-taking. We highlight an opposite effect: higher profitability loosens bank borrowing constraints. This enables profitable banks to take risk on a larger scale, inducing risk-taking. This effect is more pronounced when bank leverage constraints are looser, or when new investments can be financed with senior funding (such as repos). The model's predictions are consistent with some notable cross-sectional patterns of bank risk-taking in the run-up to the 2008 crisis.

Keywords: Banks, Risk-Taking, Leverage, Funding Structure, Crises

JEL Classification: G21, G24, G28

Suggested Citation

Martynova, Natalya and Ratnovski, Lev and Vlahu, Razvan, Bank Profitability, Leverage Constraints, and Risk-Taking (2019). Deutsche Bundesbank Discussion Paper No. 21/2019, Available at SSRN: https://ssrn.com/abstract=3422649

Natalya Martynova (Contact Author)

Deutsche Bundesbank - Research Centre ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Lev Ratnovski

International Monetary Fund ( email )

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

HOME PAGE: http://ratnovski.googlepages.com

European Central Bank, Financial Research Division

Germany

Razvan Vlahu

De Nederlandsche Bank ( email )

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

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