## Bank Profitability and Risk-Taking

_IMF Working Papers, November 25, 2015_

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**Canonical URL:** [Bank Profitability and Risk-Taking](https://www.imf.org/en/publications/wp/issues/2016/12/31/bank-profitability-and-risk-taking-43421)

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## Bibliographic details
- Authors: Natalya Martynova, Lev Ratnovski, Razvan Vlahu
- Published: November 25, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513517582.001

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### Summary and research question
- 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.

### Model setup and mechanism
- 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:
  - increases a bank’s ability to borrow;
  - enables taking side risks on a larger scale;
  - offsets the lower incentives to take risk of a given size, leading to potentially higher aggregate risk-taking.

### Key findings and consistency with evidence
- 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 areas and keywords
- 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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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/bank-profitability-and-risk-taking-43421_