{
  "title": "Bank Profitability and Risk-Taking",
  "publication": "IMF Working Papers, November 25, 2015",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2016/12/31/bank-profitability-and-risk-taking-43421",
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  "summary": "Traditional theory suggests that more profitable banks should have lower risk-taking incentives. Then why did many profitable banks choose to invest in untested financial instruments before the crisis, realizing significant losses? We attempt to reconcile theory and evidence.",
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    {
      "heading": "Summary and research question",
      "content": "- Traditional theory suggests that more profitable banks should have lower risk-taking incentives.\n- The paper asks: why did many profitable banks choose to invest in untested financial instruments before the crisis, realizing significant losses?\n- Conclusion: a more profitable core business can allow a bank to borrow more and take side risks on a larger scale, potentially increasing overall risk-taking incentives despite lower marginal incentives for a given size of risk."
    },
    {
      "heading": "Model setup and mechanism",
      "content": "- Banks are endowed with a fixed core business.\n- Banks take risk by levering up to engage in risky \"side activities\" (such as market-based investments) alongside the core business.\n- A more profitable core business:\n  - increases a bank’s ability to borrow;\n  - enables taking side risks on a larger scale;\n  - offsets the lower incentives to take risk of a given size, leading to potentially higher aggregate risk-taking."
    },
    {
      "heading": "Key findings and consistency with evidence",
      "content": "- The framework can reconcile theory and observed behavior of banks in the run up to the recent financial crisis.\n- The model is consistent with cross-sectional patterns of bank risk-taking observed before the crisis."
    },
    {
      "heading": "Subject areas and keywords",
      "content": "- Subject: Accommodative monetary policy; Bank soundness; Banking; Financial crises; Financial institutions; Financial sector policy and analysis; Financial services; Investment banking; Monetary policy; Stocks; Tax incentives\n- Keywords: Accommodative monetary policy; Bank Capital; Bank soundness; Banks; Crises; Global; interest rate; Investment banking; investment X; market-based investment; monetary policy; project investment; Repo Markets; Risk-Taking; risky investment; side investment; Stocks; WP\n\n---\n\n Content in this bundle\n\n- wp15249\n  - wp15249 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - wp15249 (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/31/bank-profitability-and-risk-taking-43421"
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    "Authors: Natalya Martynova, Lev Ratnovski, Razvan Vlahu",
    "Published: November 25, 2015",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781513517582.001",
    "Traditional theory suggests that more profitable banks should have lower risk-taking incentives.",
    "The paper asks: why did many profitable banks choose to invest in untested financial instruments before the crisis, realizing significant losses?",
    "Conclusion: a more profitable core business can allow a bank to borrow more and take side risks on a larger scale, potentially increasing overall risk-taking incentives despite lower marginal incentives for a given size of risk.",
    "Banks are endowed with a fixed core business.",
    "Banks take risk by levering up to engage in risky \"side activities\" (such as market-based investments) alongside the core business.",
    "A more profitable core business:",
    "The framework can reconcile theory and observed behavior of banks in the run up to the recent financial crisis.",
    "The model is consistent with cross-sectional patterns of bank risk-taking observed before the crisis.",
    "Subject: Accommodative monetary policy; Bank soundness; Banking; Financial crises; Financial institutions; Financial sector policy and analysis; Financial services; Investment banking; Monetary policy; Stocks; Tax incentives",
    "Keywords: Accommodative monetary policy; Bank Capital; Bank soundness; Banks; Crises; Global; interest rate; Investment banking; investment X; market-based investment; monetary policy; project investment; Repo Markets; Risk-Taking; risky investment; side investment; Stocks; WP",
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