Sustainable profitability in volatile cyclical markets

Abstract

Market conditions are prone to change rapidly, limiting the ability of lenders to mitigate losses. Furthermore, lenders’ behaviour can often contribute to market volatility as lending initially drives up market leverage, and this is followed by greatly reduced credit supply following a market correction as capital constraints and heightened risk sensitivities constrict banks’ willingness to lend. This paper analyses how banks can successfully ensure it is being rewarded for the risk presented by a cyclical and volatile market. It also discusses how a bank can avoid presenting its shareholders with loss of their capital without missing profitable lending opportunities? In short, how should a bank seek commercial sustainability in volatile cyclical markets?