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Bank profitability, leverage constraints, and risk-taking

Natalya Martynova, Lev Ratnovski () and Razvan Vlahu ()

No 21/2019, Discussion Papers from Deutsche Bundesbank

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: 2019
New Economics Papers: this item is included in nep-ban and nep-ore
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