Bank risk in a decade of low interest rates

Abstract

A low interest rate regime remains in place in the U.S. after the Financial Crisis of 2008. Banks nevertheless need to find ways to boost the economic value to shareholders. This research examine whether it is possible for banks to stay the course and pursue profitable yet riskier assets or investments regardless of the fact that regulators have put restrictions on banks’ asset portfolio formation and capital ratio. This study hypothesizes that banks still engage in highly risky yet profitable investments or services to offset low interest income even after the 2008 Financial Crisis. A panel VAR model and a dynamic GMM model incorporating two structural breaks are employed to examine bank data obtained from the FFIEC from 2003 thru 2014. This study suggests that banks, especially larger banks, still have strong incentives to undertake riskier projects with higher expected returns in order to increase their performance. This has implications for policy makers examining risks inherent to the banking system.