Matthew Osborne, Alistair Milne & Ana-Maria Fuertes.

Does the risk appetite of banks vary over the cycle? Our recent research paper sheds light on this issue by examining the time-varying correlation between banks’ capital ratios and lending rates which cannot be explained by bank characteristics, such as capital requirements, portfolio risk, size and market share, or macroeconomic factors.  The relationship notably differs between episodes of rapid credit expansion (“good times”), and episodes of crisis with moderate or negative credit growth (“bad times”).  This is difficult to reconcile with traditional theories of bank intermediation, but is consistent with recent theories emphasising cyclical variation in bank leverage and risk appetite.

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