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Leverage and risk in US commercial banking in the light of the current financial crisis

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  • Papanikolaou, Nikolaos I.
  • Wolff, Christian C

Abstract

In this paper we study the relationship between leverage and risk in commercial banking market. We employ a panel data set that consists of the biggest US commercial banks and which extends from 2002 to 2010 thus covering both the years before the outbreak of the current financial crisis as well as those followed. We make clear distinctions among different leverage types like on- and off-balance sheet leverage as well as short- and long-term leverage, which have never been made in the relevant literature. Our findings provide evidence that excessive leverage, both explicit and hidden off-the-balance sheet, rendered large banks vulnerable to financial shocks thus contributing to the fragility of the whole banking industry. In a similar vein, a direct link between short- and long-term leverage with risk is reported before the crisis, showing that leverage has been one of the key factors responsible for the serious liquidity shortages that were revealed after 2007 when the crisis erupted. We also demonstrate that banks which concentrate on traditional banking activities typically carry less risk exposure than those that are involved with modern financial instruments. Overall, our results provide a better understanding of the role of leverage in destabilizing the whole system whereas at the same time contribute to the current discussion on the resilience of the banking sector through the strengthening of the existing regulatory framework.

Suggested Citation

  • Papanikolaou, Nikolaos I. & Wolff, Christian C, 2015. "Leverage and risk in US commercial banking in the light of the current financial crisis," CEPR Discussion Papers 10890, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10890
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    References listed on IDEAS

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    Cited by:

    1. repec:gam:jjrfmx:v:10:y:2017:i:2:p:8-:d:95645 is not listed on IDEAS
    2. Ojo, Marianne, 2012. "Bailouts and longer term refinancing operations (LTROs): when temporary cures generate longer term economic concerns," MPRA Paper 38483, University Library of Munich, Germany.
    3. Mariana Laverde & Esteban Gómez & Miguel Ángel Morales Mosquera, 2011. "Measuring Systemic Risk in the Colombian Financial System: Systemic Contingent Claims Approach," Temas de Estabilidad Financiera 060, Banco de la Republica de Colombia.
    4. Ojo, Marianne, 2010. "Preparing for Basel IV (whilst commending Basel III) : why liquidity risks still present a challenge to regulators in prudential supervision ( Part II)," MPRA Paper 32630, University Library of Munich, Germany.
    5. Gastón Andrés Giordana & Ingmar Schumacher, 2017. "An Empirical Study on the Impact of Basel III Standards on Banks’ Default Risk: The Case of Luxembourg," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 10(2), pages 1-21, April.

    More about this item

    Keywords

    commercial banking; financial crisis; leverage; risk;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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