Risky Adjustments or Adjustments to Risks : Decomposing Bank Leverage

This paper separates short- and long-run dynamics of bank leverage by use of cointegration analysis. With respect to the long-run, if banks' leverage ratio or related liability shares are constant over time, they form a cointegrating relationship. Thus, cointegration tests indicate whether banks target certain liability ratios and whether they have been able to achieve this aim during the banking crisis in 2008. My results reveal that liability ratios are cointegrated only after accounting for structural breaks in the funding conditions of banks. By estimating coefficients on these structural breaks, I can trace the channels of banks' leverage adjustment and unveil their liability reallocations in response to key changes in their funding conditions. With respect to the short-run view, I study the interplay of bank liabilities to correct for deviations from the long-run ratios and their adjustments to changes in financial market risks. In brief, my findings suggest that substantial heterogeneity governs the adjustment patterns of different banking groups to both, key ruptures in their funding conditions and changes in financial market risks