Bank profitability, leverage constraints, and risk-taking

Natalya Martynova, Lev Ratnovski () and Razvan Vlahu

Journal of Financial Intermediation, 2020, vol. 44, issue C

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 (search for similar items in EconPapers)
JEL-codes: G21 G24 G28 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (14)

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Working Paper: Bank profitability, leverage constraints, and risk-taking (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:44:y:2020:i:c:s1042957319300233

DOI: 10.1016/j.jfi.2019.03.006

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