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Active Risk Management and Banking Stability

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  • Silva Buston, C.F.

    (Tilburg University, Center For Economic Research)

Abstract

This paper analyzes the net impact of two opposing effects of active risk management at banks on their stability: higher risk-taking incentives and better isolation of credit supply from varying economic conditions. We present a model where banks actively manage their portfolio risk by buying and selling credit protection. We show that anticipation of future risk management opportunities allows banks to operate with riskier balance sheets. However, since they are better insulated from shocks than banks without active risk management, they are less prone to insolvency. Empirical evidence from US bank holding companies broadly supports the theoretical predictions. In particular, we find that active risk management banks were less likely to become insolvent during the crisis of 2007–2009, even though their balance sheets displayed higher risk-taking. These results provide an important message for bank regulation, which has mainly focused on balance-sheet risks when assessing financial stability.
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Suggested Citation

  • Silva Buston, C.F., 2013. "Active Risk Management and Banking Stability," Discussion Paper 2013-068, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:18a8d09e-79af-4993-8d64-b01ef455eaa3
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    Cited by:

    1. Schaeck, K. & Silva Buston, C.F. & Wagner, W.B., 2013. "The Two Faces of Interbank Correlation," Discussion Paper 2013-077, Tilburg University, Center for Economic Research.
    2. Schaeck, K. & Silva Buston, C.F. & Wagner, W.B., 2013. "The Two Faces of Interbank Correlation," Other publications TiSEM 01f35859-2db3-4c16-8054-e, Tilburg University, School of Economics and Management.
    3. Tsuji, Chikashi, 2020. "Correlation and spillover effects between the US and international banking sectors: New evidence and implications for risk management," International Review of Financial Analysis, Elsevier, vol. 70(C).
    4. R. Rupeika-Apoga & S.H. Zaidi & Y.E. Thalassinos & E.I. Thalassinos, 2018. "Bank Stability: The Case of Nordic and Non-Nordic Banks in Latvia," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(2), pages 39-55.
    5. Schaeck, K. & Silva Buston, C.F. & Wagner, W.B., 2013. "The Two Faces of Interbank Correlation," Other publications TiSEM 20f96e3f-e3fb-428f-83de-2, Tilburg University, School of Economics and Management.
    6. Chunyang WANG & Yongjia LIN, 2018. "The Influence of Income Diversification on Operating Stability of the Chinese Commercial Banking Industry," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(3), pages 29-41, September.
    7. repec:ers:journl:v:vi:y:2018:i:2:p:39-55 is not listed on IDEAS

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    More about this item

    Keywords

    Financial innovation; credit derivatives; financial stability; financial crisis;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services

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