Bank capital allocation under multiple constraints

Goel, Tirupam; Lewrick, Ulf; Tarashev, Nikola

doi:10.1016/j.jfi.2019.100844

Cited by 13 publications

(12 citation statements)

References 39 publications

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“…The framework of our model, which views a bank as a combination of businesses with different risk properties, is common in the literature on financial conglomerates (Santos, 1998;Freixas et al, 2007;Boot and Ratnovski, 2016; and more recently Chami et al, 2017;and Goel et al, 2017). The focus of our analysis is different from other papers in this literature.…”

Section: Introductionmentioning

confidence: 99%

Bank profitability, leverage constraints, and risk-taking

Martynova

Ratnovski

Vlahu

2020

Journal of Financial Intermediation

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Research Question The 2008 crisis revealed a surprising amount of risk-taking in very profitable financial institutions. This seems to contradict the traditional predictions of corporate finance models where more profitable firms take less risk, because their shareholders stand to lose more if downside risks realize (Keeley, 1990). Understanding why some of the most profitable financial institutions chose to become exposed to risky market-based instruments on a large scale seems critical for both bank risk management and systemic risk regulation. Contribution In traditional corporate finance models, banks choose the risk of a portfolio of a fixed size. We show that bank risk-taking may take a different form when balance sheet size is a bank's choice. In our model, banks are endowed with a stable 'core business' and choose the size and risk of the market-based investments undertaken alongside their core business. Higher profitability of their core business enables banks to borrow more and engage in risky side activities on a larger scale. Results The model offers predictions that are consistent with some notable patterns of banks' precrisis risk-taking. One pattern is that many banks affected by the crisis were in advanced, rather than developing economies. Our model suggests that risk-taking in profitable banks is more likely when bank leverage constraints are looser, consistent with buoyant credit markets and a pre-crisis weakening of bank capital regulation in many advanced economies. Another pattern is the role of senior funding (e.g. repo) in supporting banks' pre-crisis expansion. Consistent with this evidence, our model confirms that banks' risk-taking in side investments is more severe when these can be financed with senior debt.

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Section: Introductionmentioning

confidence: 99%

Bank profitability, leverage constraints, and risk-taking

Martynova

Ratnovski

Vlahu

2020

Journal of Financial Intermediation

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“…Studies have shown that sufficient holdings of such assets reduce the overall credit risk in banks' balance sheets (Banerjee and Mio, 2015;Bonner, 2015;Duijm and Wierts, 2016). An abundant literature deals with the interaction of the weighted (CR) and unweighted (LR) capital requirements (Goel et al, 2017;Pfeifer et al, 2017;Mankart et al, 2018) but abstracts from the effect of liquidity requirements. Similarly, the literature also examines the relationship between the CR and LCR requirements but abstracts from the effect of the LR and the NSFR ones (Behn et al, 2019).…”

Section: Introductionmentioning

confidence: 99%

The relationship between capital and liquidity prudential instruments

2020

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The risks associated with credit and liquidity positions and asset and liability maturity mismatches are mitigated by applying capital ratio, leverage ratio, liquidity coverage ratio and net stable funding ratio requirements to banks. As a macroprudential authority, the Czech National Bank moreover responds to changes in systemic risk by changing the capital buffer requirements. This can induce a reaction by banks leading to a change in their balance-sheet structure, which, in turn, will affect their degree of fulfilment of all the requirements. This article analyses the relationship between the regulatory capital and liquidity instruments by studying banks' response to an increase in the countercyclical capital buffer rate and a subsequent economic downturn. The results reveal that it is vital for macroprudential authorities to look at the initial levels of the other required ratios before starting to change the countercyclical capital buffer rate if they are to maximise the effectiveness of the latter.

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“…Closely related is the paper by Mankart et al (2018), who develop a dynamic structural banking model to examine the interaction between risk-weighted capital ratios and unweighted leverage requirements while abstracting from the liquidity dimension. The same applies to Goel et al (2017), who take a capital allocation perspective and also study the interaction between risk-based capital requirements and a simple leverage ratio. The interaction between Basel III type capital and liquidity requirements is studied by Cecchetti and Kashyap (2016) and Chami et al (2017).…”

Section: Introductionmentioning

confidence: 99%

A Dynamic Model of Bank Behaviour under Multiple Regulatory Constraints

2019

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We develop a dynamic structural model of bank behaviour that provides a microeconomic foundation for bank capital and liquidity structures and analyses the effects of changes in regulatory capital and liquidity requirements as well as their interaction. Our findings suggest that adjustments in both types of requirements can have an impact on loan supply, with considerable heterogeneity across banks and over time. The model illustrates that banks' reactions depend on initial balance sheet conditions and reconciles evidence on short-term reductions in loan supply with findings suggesting that better capitalized banks are better able to lend in the medium-to long-term.

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Bank capital allocation under multiple constraints

Cited by 13 publications

References 39 publications

Bank profitability, leverage constraints, and risk-taking

Bank profitability, leverage constraints, and risk-taking

The relationship between capital and liquidity prudential instruments

A Dynamic Model of Bank Behaviour under Multiple Regulatory Constraints

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