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Bank profitability, leverage constraints, and risk-taking

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  • Martynova, Natalya
  • Ratnovski, Lev
  • Vlahu, Razvan

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.

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  • Martynova, Natalya & Ratnovski, Lev & Vlahu, Razvan, 2020. "Bank profitability, leverage constraints, and risk-taking," Journal of Financial Intermediation, Elsevier, vol. 44(C).
  • Handle: RePEc:eee:jfinin:v:44:y:2020:i:c:s1042957319300233
    DOI: 10.1016/j.jfi.2019.03.006
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    More about this item

    Keywords

    Banks; Risk-taking; Leverage; Funding structure; Crises;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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