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Optimal versus realized bank credit risk and monetary policy

Delis, MD and Karavias, I (2015) Optimal versus realized bank credit risk and monetary policy Journal of Financial Stability, 16. pp. 13-30.

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Standard banking theory suggests that there exists an optimal level of credit risk that yields maximum bank profit. We identify the optimal level of risk-weighted assets that maximizes banks’ returns in the full sample of US banks over the period 1996–2011. We find that this optimal level is cyclical for the average bank, being higher than the realized credit risk in relatively stable periods with high profit opportunities for banks but quickly decreasing below the realized in periods of turmoil. We place this cyclicality into the nexus between bank risk and monetary policy. We show that a contractionary monetary policy in stable periods, where the optimal credit risk is higher than the realized credit risk, increases the gap between them. An increase in this gap also comes as a result of an expansionary monetary policy in bad economic periods, where the realized risk is higher than the optimal risk.

Item Type: Article
Divisions : Faculty of Arts and Social Sciences
Authors :
Date : February 2015
Additional Information : NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Financial Stability. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Financial Stability, 16, February 2015, DOI 10.1016/j.jfs.2014.11.004.
Depositing User : Symplectic Elements
Date Deposited : 03 Feb 2015 12:59
Last Modified : 27 May 2016 16:08

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