Abstract
This paper presents a theoretical foundation for bank leverage heterogeneity in the cross-section and through the cycle. Based on empirical evidence, we model banks' balance sheet management as being constrained by Value-at-Risk. Since global banks have more diversified investment opportunities than regional banks, they are better protected against region specific risks and thus have a higher debt capacity than regional banks. However, this diversification advantage exposes global banks to more non-diversifiable risk compared to regional banks. Hence, their leverage is affected stronger by changes in the global economic conditions. Furthermore, the paper shows that an interbank market emerges as a result of changes in disparities in regional risks and that global banks can channel funds from risky regions to safe regions. This increases the leverage of global banks even further.
Published Version
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